The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
We attribute the strong yield drop of 4Q23 to a reversal of the sharp r* increase fears of 3Q23, rather than bets on economic downturn. Of note, the Fed’s actual r* estimate was halved in 4Q23. For the Fed, the core policy risk is shifting from under-tightening to over-tightening. We expect the January FOMC to be a repeat of December.
Sharp yield drop in 4Q23 was reversal of 3Q23 surge, not a bet on downturn
Recent discussions over a rise in the neutral interest rate (r*) reflected 3Q23’s yield surge. Main arguments cited: 1) the expansion of US government debt; and 2) the sudden jump in US productivity. However, confirmation has arrived of both a reduction of fiscal deficit as a percentage of GDP and a peak out of tangible asset investment growth in 4Q23. After climbing steeply in 3Q23, the Fed’s official r* estimate was halved in 4Q23. We attribute the swift pullback of 4Q23 to a reversal of the sharp r* increase fears of 3Q23. In other words, we are witnessing normalization.
Implications of r* cut: Worry turns from under-tightening to over-tightening
The implication of the downward adjustment in estimated r* is that the Fed’s core policy concern is shifting from under-tightening to over-tightening. We view Powell’s change of stance at the December FOMC meeting as being natural given the Fed’s slashing of its r* estimate. In our view, the January FOMC is more likely to be a repeat of December than a hawkish surprise. However, additional evidence is needed to verify the direction of r* after the bond market normalization of 4Q23. In January, 10yr US TB yield is likely to remain steady in a box range as the market digests the relevant indicators.
Neutral policy rate determines whether central banks tighten or not
According to the BOK Governor’s New Year’s speech, price control is the top priority, and domestic conditions are to be given increasing focus in policy decisions. We note that the current policy rate of Korea is more than 100bp above the neutral policy rate. In other words, even if the BOK cuts the policy rate, we would likely remain in tight territory in terms of price control. Despite price burden, it is difficult to hold no expectations for a cut in the BOK’s policy rate.