Central banking principles

The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.

According to their monetary principles, central banks respond to fundamentals with base rate policy and to financial instability with temporary liquidity provision. Expectations for a rate hike or cut based on financial instability run contrary to such principles. We expect a 25bp hike at the March FOMC.

Central banking principles: Base rate policy for fundamentals, liquidity provision for financial turmoil

Banking event risks are emerging, including the SVB failure and Credit Suisse situation. In line, some have raised the possibility of rates being left unchanged, or even cut, at the March FOMC, due to the transferability of systemic risk.

Against this backdrop, it is worth revisiting the UK situation of last year. In late-Sep 2022, the UK bond market saw a spike in bond yields due to government shortcomings. In response, the BOE implemented unlimited quantitative easing for a certain period. Later, after the market stabilized, the BOE hiked rates by 75bp at its November policy meeting. A key principle of central banks is to respond to fundamentals with base rate policy and to financial instability with temporary liquidity provision. Of note, the BOK’s response to the Legoland crisis was based on these same principles.

Any response to the recent uptick in financial instability in the way of a freeze or cut to base rates would be inconsistent with central banks’ core policy. The Fed has already provided liquidity through the establishment of the BTFP facility, as well as large-scale funding through the rediscount window. In our view, the chances of a policy response are limited.

Ultimately, a rate hike at the March FOMC is inevitable. We believe that a 25bp hike is most likely, given that: 1) as the amount borrowed by banks through the rediscount window last week was above financial crisis levels, some time will be needed to assess the market impact; and 2) February m-m retail sales growth came in negative. With the end of this rate hike cycle increasingly coming into view, strong curve flattening pressure is expected as consumption indicators slow. We expect negative long-short yield spreads to further widen.

Korea’s credit card usage indicates end to retaliation spending

Monetary policy divergence between countries that are already seeing the effects of rate hikes and those that are just beginning to do so is natural. In the US, services consumption is still above trend, and service price level decline remains unremarkable ‘for now’. Against this backdrop, further hikes appear needed.

In South Korea, however, estimates of service-related credit card spending (based on Statistics Korea data) show a drop to below pre-Covid-19 levels since end-2022. With consumption of both goods and services now under the pre-Covid-19 levels, there would seem to be little benefit from further disrupting demand through additional hikes. We believe that Korea’s rate hike cycle has ended.