Fixed Income Weekly
The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
Following the debt ceiling deal, we expect the US government and Fed’s ‘double QT’ to replace rate hikes. In Dec 2021, the US government’s short-term borrowing led to shrinking MMF balances, a higher RRP rate, and a reduction in reserves. A tightening in liquidity is expected this time, too.
US government and Fed’s ‘double QT’ and FDIC’s 1Q23 banking report
We have argued that May was a de facto QE month, with the government’s cash release (US$246.7bn) far outsizing the Fed’s QT (US$95bn), while pointing to the government’s ‘free spending’ as being a key driver of the lull in the banking crisis and spike in rates. On this basis, we have been predicting a ‘double QT’ by the US government and Fed in the event of a debt ceiling deal, which should replace a June rate hike, reignite some small/mid-sized bank risk, and push rates lower. The slide in Treasury yields last week after news of the White House and Republican debt deal supports our outlook.
Of course, MMF purchases of short-term Treasurys (RRP → short-term Treasurys) should offset some of the tightening. Indeed, 2~6-month T-bill yield is currently above the benchmark rate, suggesting that some MMF funds will be utilized to purchase short-term bonds. However, even when 1yr yield was above the benchmark rate at the time of the debt ceiling deal in Dec 2021, while the government was borrowing cash, reserves shrank steeply, MMF balance declined slightly, and RRP balance rose steadily. Against this backdrop, we expect liquidity reduction effects this time around, as well.
Questions surround the potential for: 1) risk reappearance at some small/mid-sized banks during the tapering process; and 2) accelerated loan contraction. Last week, the FDIC’s 1Q23 banking report showed that the number of banks on the Problem Bank List increased q-q by four and by around US$11bn in assets at risk of default. Of note, as the SVB failure was in March and the FRC failure was in April, the 1Q23 data may not fully reflect bank issues. Meanwhile, the Dallas Fed’s bank survey reveals that banks continued to tighten lending standards in May. Given the above, the Fed will need time in June to assess bank credit conditions and the likelihood of a re-emergence of banking risks. We expect the FF rate to remain unchanged in June.
Service prices linked with supply-side inflation
A report recently released by the BOE indicates that supply-side inflation is the largest contributor to the rise in service prices. At home, the BOK pointed out in a recent blog that the surge in import prices in 2022 had a significant impact on core inflation. A keynote speech at the BOK International Conference last week noted that the pandemic inflation spike was driven by: 1) supply-side inflation; and 2) corporate profit expansion, rather than demand growth. Moving ahead, second-round impacts of supply-side inflation are expected to act as base effect.