Fixed income strategy
The author is an analyst for Shinhan Securities. He can be reached at jk.ahn@shinhan.com -- Ed.
US yields to slow their rise after May CPI release and June FOMC meeting
The market’s focus is now shifting to the US Fed’s FOMC meeting on June 13-14 (local time). KTB yields have been on a steep uptrend from mid-May, along with a rebound in US Treasury yields. Since then, the US debt ceiling deal has been agreed and expectations for rate cuts this year have been dampened by stubbornly high core inflation. The upcoming FOMC meeting will provide a glimpse of the Fed’s assessment of the debt limit deal and inflation. We will need to watch for the US central bank’s rate decision and new dot plot at its June policy meeting.
We expect further tightening worries to ease upon the release of the US Consumer Price Index (CPI) for May. Actual CPI growth stayed above Bloomberg median forecasts between 2H21 and 1H22, causing inflation risk premium to jump and the Fed to respond with aggressive monetary tightening that resulted in a steep rise in US Treasury yields. With inflation risks declining since 4Q22, overall CPI growth and core CPI for May should be more or less in line with the median forecasts. On a MoM basis, we project core CPI growth to fall slightly short of the consensus median estimates (0.4%).
The confirmation of softer-than-expected US core inflation for May should also help to remove concerns over the June FOMC meeting. The Fed will stay on its hawkish course, but downward stabilization of inflation will provide grounds to keep policy rate and dot plot unchanged. The 10Y US Treasury yield, which has climbed up to 3.8%, is forecast to slow its ascent if the probability of additional rate hike in July falls from current 68%. Despite lowered expectations for US rate cuts this year, the 10Y US Treasury yield is unlikely to rise further to the 4% range. Heightened external uncertainties ahead of the June FOMC meeting will likely weigh on the domestic bond market.
BOK to maintain its policy stance for the time being
The recent rate increases in Australia and Canada show that central banks are seeking different policy responses to address local issues. Lingering upward pressure on inflation may call for additional tightening down the road. In Korea, high household debt levels driven by mortgage loans have raised fears of further rate hikes. Talks of recovery of the housing market is burdensome, which have been spurred by increases in apartment sales and rental transactions since February, as well as lower mortgage loan rates from the rate freeze.
The Bank of Korea (BOK) is forecast to remain hawkish through July in its efforts to deal with household debt and inflation. With rate cuts unlikely within the remainder of the year, the spread between the 3Y KTB yield and the benchmark rate should not widen beyond 10bp even after the FOMC meeting in June. The 3Y KTB yield is projected to move in the 3.40-3.60% range through the July Monetary Policy Board meeting. However, fears of economic slowdown should continue amid high interest rates. We recommend taking a buying approach when yields on major KTBs near 3.60%.