Fixed Income Weekly
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
The Fed’s official forecast includes the entering of a mild recession at the end of this year. Given that monetary tightening should become more difficult toward yearend, we expect that the Fed will hike in May, taking advantage of the time lag between: 1) a lull in banking-related events; and 2) the realization of a recession. Curve flattening is anticipated.
Fed to do what it can, while it can
The US banking situation has entered a lull. Looking at commercial bank capital flows since the SVB bankruptcy, both small and large banks have seen new deposit inflows over the past two weeks. In addition, commercial banks’ borrowing from the Fed through the discount window and BTFP has now declined for a fourth consecutive week. Although the possibility of additional credit events cannot be ruled out, it is difficult to assume their occurrence as a base scenario for monetary policy projections.
For the Fed, the easing in the banking situation should buy some time. In the March FOMC minutes, for the first time, the prospect of entering a mild recession at yearend was confirmed. Although it is not a unanimous position among Fed members, only Fed economists, it is important that the Fed’s official stance has shifted to include a mild recession.
US March retail sales (m-m) announced last week showed negative growth for a second month in a row, as expected. In addition, the pace of increase in service prices (m-m), excluding housing costs, which Powell has pointed to as being a key variable, also declined. Such ingredients both support the Fed’s official outlook (mild recession) and point to the realization of the Fed’s ultimate goal.
What is important is the time lag between the Fed’s projections and the realization of such forecasts. From the Fed’s point of view, as a recession is not here yet, further rate hikes can be tolerated, and with the banking situation having cooled off, planned tightening will be carried out. In other words, the Fed is to do what it can, while it can. Expectations for a rate freeze in May are overblown. However, after a rate hike in May, the stance should change to freeze. Curve flattening is to return.
BOK rate hike in 2H23 even less likely than in 2Q23
In April, the MPC unanimously left the base rate unchanged, as predicted. The governor emphasized that although inflation should fall rapidly in 2Q23, the trajectory of inflation in 2H23 is unknown, and further rate increases are possible if necessary, depending on price conditions.
However, US-related factors are now to be considered in 2H23 hike forecasts. The dot plot is suggesting that the US’s last rate hike will be in 2Q23, and the US Fed’s official stance is the entering of a mild recession at yearend. In other words, for Korea to raise the benchmark rate in 2H23, the upward momentum of Korean inflation would have to outweigh the economic slowdown caused by the US entering a mild recession, which is unlikely. Therefore, believing that Korea’s hike cycle has already ended, we maintain our forecast of a 4Q23 rate cut.