The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
The Fed's rate cut playbook emphasizes cuts sooner rather than later and further tightening. With this in mind, we anticipate bullish steepening of yield curves starting from 2Q24. The US and EU are starting to coordinate the timing of rate cuts. Korea may also enter the fray as it has the lowest core inflation rate among major economies.
Fed's rate cut playbook: No delay in cuts and further tightening
The two main takeaways of Jerome Powell's congress testimony are: 1) it will not take long for the Fed to have confidence to cut rates; and 2) the Fed plans to reduce bond maturities and MBS holdings. In other words, the Fed’s playbook includes cutting rates without delay to influence the real market through the real interest rates, and further tightening to directly affect the asset markets.
Indeed, February’s employment data supports Powell's intentions. Although new non-farm payrolls exceeded expectations, January’s new payrolls were sharply revised downwards from 353,000 to 229,000. Additionally, the February unemployment rate rose by 0.2%p, significantly exceeding expectations, while wage growth was below forecasts. We predict that with the slope of the Beveridge curve normalizing, employment data will reach the Fed’s desired level by 2Q24. We maintain our forecast for a first FF rate cut in June.
Regarding liquidity, both Waller and Powell, the latest Fed opinion leaders, have expressed negative views on holding MBSs. As housing costs act as a barrier to disinflation, there seems to be no disagreement within the Fed about reducing MBS holdings. Also, lowering bond maturity should induce a reduction in the balance sheet through redemptions. Overall, we confirm the intention for further tightening.
Considering the Fed's playbook, we expect to see bullish steepening of the yield curve, beginning from 2Q24, when rate cut discussions should start in earnest
Lagarde's hint and BOK’s MPC meeting
The ECB left rates unchanged at its meeting last week. However, it cut its 2024 GDP growth forecast to 0.6%; growth projections have been lowered at every meeting since Sep 2022.
Amid slowing demand, the ECB has also revised down core inflation forecasts at every meeting since Sep 2023, with the forecast for 2024 standing at 2.6%. Christine Lagarde hinted at a rate cut in June, stating in her March press conference that ‘we will know a lot more about inflation stabilization in June.’ We also anticipate an ECB rate cut in June.
Both the US and EU are starting to coordinate the timing of rate cuts. Currently, core inflation in the US, EU, and Korea stand at 3.9%, 3.1%, and 2.5%, respectively, with Korea’s core inflation rate stabilizing fastest among major economies. We expect the BOK to start rate cut coordination, as well.