Monday, March 30, 2020
Fixed Income Weekly: BOK’s Dilemma
BOK Expected to Cut Rate in 2Q20
Fixed Income Weekly: BOK’s Dilemma
  • By Kang Seung-won
  • February 18, 2020, 11:45
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The author is an analyst of NH Investment & Securities. He can be reached at -- Ed.


The Dollar Index has again hit the 99pt mark. While the Fed’s GDP gap forecast for this year stands at 0.1%p, the burden of the strong US dollar calls for a rate cut by the Fed. Despite governor Lee Ju-yeol’s remarks over the potential side effects of a rate cut, we still expect the BOK to make a base rate cut in 2Q20.

Fed to feel pressure of strong US dollar

December industrial output by major eurozone economies, including Germany, disappointed market forecasts. Given that industrial production in Europe slowed significantly in 4Q18 on stricter emission regulations, the data for December should have enjoyed low-base effects, making its poor performance stand out more. Of note, Germany’s IFO auto production index fell sharply in January, with the six-month moving average touching the lowest witnessed since May 2013. Doubts are mounting towards the chances of a rebound in its car production in 1Q20, given that the impact of slowing demand in China due to the novel coronavirus (Covid-19) outbreak has yet to be fully reflected. The euro has plunged 3.4% YTD, and the Dollar Index has upped to 99pt on the eurozone economic burden.

Currently, according to its December dot plot, the Fed offers a 1.9% potential (long-run) growth rate for US and a 2.0 percent growth forecast for 2020. With a GDP gap of only 0.1%p, the strong US dollar is threatening a significant economic burden. In the report to Congress last week, Fed Chair Powell did not provide interest rate policy guidance; however, we stick to our established opinion that a rate cut will be hinted at in 2Q20 in the face of the Fed reducing its liquidity supply.

Even with Governor Lee’s comments, we maintain 2Q19 rate cut view

After the recent (Feb 14) macroeconomic and finance meeting, governor Lee Ju-yeol said: “We cannot quantify the influence of the coronavirus outbreak yet, and we will be careful in cutting the benchmark rate because of the potential side effects.” The side effects mentioned are likely to include real estate price-related household debt. But, the hint garnered from the governor’s remarks is that BOK’s stance might change once: 1) the impact of the Covid-19 outbreak can be quantified and 2) the household debt burden starts to ease.

In our annual outlook, we predicted that there will be: 1) a Korean base rate cut in 2Q20 (at which time the impacts of the government’s new real estate measures should materialize); and 2) an amplifying in calls for Fed to make a federal funds rate cut. Of note, 1Q20 domestic GDP is to be burdened by: 1) high-base effects stemming from a surprisingly high 4Q19 GDP growth rate in response to public construction projects; and 2) the ramifications of the Covid-19 outbreak. As such, 1Q20 GDP (to be announced on Apr 23) will likely be weaker than earlier predictions, in turn serving as a justification for lowering the key rate. Thus, despite Governor Lee’s remarks, we still expect to see a rate cut in 2Q120.

But, damage to market sentiment appears unavoidable as KTB yields had already priced in the possibility of a base rate cut this month. Of note, market attention is to be focused on whether foreign demand (for which a KTB 3y futures position has been aggressively expanded as of late) will still hold steady.