Fixed Income Weekly
The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
The Fed’s June pause was a move to slow hikes down to 12.5bp. A July FOMC rate hike seems inevitable. However, the July hike may be the last given the steep decline in core service prices and shrinking bank reserves. In July, we expect a hawkish BOK to announce a unanimous rate freeze.
June freeze was to slow hikes to 12.5bp; now the focus is on September
A 25bp hike at the July FOMC meeting seems inevitable. The June FOMC minutes confirm that the June rate freeze was a form of pacing—ie, by taking a break in June and hiking 25bp in July, the effect would be to raise rates by 12.5bp in June and July. Chairman Powell's "not ruling out two consecutive hikes" comment at the Sintra Forum was not a repeat of the June FOMC, but rather a signal of a possible reacceleration from 12.5bp to 25bp. The upward shift in the US TB yield curve since July is a result of fears of that possible reacceleration.
Ultimately, whether we get a hike September after a raise in July is the main focus. We maintain our view that the July hike, if it happens, will be the last. The ISM Services Price Index fell further in June to the lowest level since Apr 2020, just after Covid-19 broke out. Excluding housing, core services prices should continue to decline. In addition, the Manheim Used Car Index, a leading indicator of used car prices that was a key upside driver of core inflation in April and May, has fallen sharply for three consecutive months. Signs of stabilization in core inflation are expected.
Furthermore, if the FF rate is hiked in July, the RRP rate, which competes with short-term yields, would exceed the one-month TB yield, a key target for government bond MMFs. By September, bank reserves are expected to reach the US$2.5tn~2.7tn-level that the Fed has cited as its minimum benchmark. We maintain our view that the July hike will be the last and that liquidity reduction will be the key tool for Fed tightening thereafter.
July BOK meeting: Hawkish BOK to announce unanimous rate freeze
A unanimous rate freeze is expected in July. At the May meeting, the BOK raised its forecast for core inflation and unanimously decided to keep rates unchanged. Also, during the inflation briefing, the BOK governor noted that members were already factoring in one more Fed hike. In other words, the unanimous May decision was based on an upwardly revised view of core inflation and the likelihood of one more Fed hike.
Electricity prices should remain flat in 3Q23, and food prices started to be cut from June. In addition, service prices fell sharply last month, led by food prices. Jeonse (lump-sum rent) price growth in the CPI basket has nearly reversed to a negative level. Inflationary conditions have improved since May. While a July Fed hike is inevitable, it is too early to tell if there will be more hikes after July. We expect the July MPC meeting to return a hawkish unanimous rate freeze decision, as was the case in May.