Fed to Slow down Speed of Liquidity Supply
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
Estimating its remaining firepower at around US$2tn, we expect the Fed to transition to a cautious stance. The BOK’s new measure of lending to non-banking financial institutions reflects its willingness to provide direct liquidity. KTB direct purchases should increase quickly going forward.
Fed to slow down speed of liquidity supply
With the US continuing to report dismal economic indicators, Bloomberg’s US GDP growth consensus is being revised down further. The WTI price has also fallen below US$20/bbl again. With this in mind, we decided to estimate the size of the Fed’s remaining resources to buy assets other than US TBs and MBSs. Thus far, the US Treasury has deposited US$454bn into the Exchange Stabilization Fund (ESF) under the CARES Act. Given the Fed’s recent policy measures and the fact that the leverage ratio for asset purchases can rise to 10 times the amount deposited in the ESF, we believe that it has room for a further US$2tn in policy funding.
While it remains possible to secure additional funding, the Fed’s assets have already ballooned to a third of US real GDP. With leftover resources smaller than the recent US$2.3tn in stimulus loans, a hasty policy maneuver could be seen as a waste of the Fed’s ammunition. It is likely that the central bank will transition to a more cautious monetary easing stance going forward. We note that the Fed’s daily purchases of US TB and MBS have already declined from US$75bn and US$50bn, respectively, to US$15bn and US$10bn.
Reducing US TB purchases will likely create unfavorable supply-demand conditions; however, given that risky assets appear to have benefited most from increased liquidity supply, and further given the downward revision of growth forecasts, we expect US TB yields to continue trading within a range.
Won-denominated bond market shedding discount factor
Led by a surge in construction investment, Korea’s 4Q19 GDP growth came in at a surprising 1.2%. Therefore, it is likely that 1Q20 GDP (reported this week) will record negative q-q growth. We also point out that employment in March plunged, centering on the wholesale and retail industries. The wholesale and retail industries account for 23% of domestic employment, but only 9.4% of GDP. Given the miss match, massive jobs losses could induce hysteresis in the domestic labor market.
Thus, we expect a third supplementary budget to follow the second W7.6tn budget announced by the government last week. All of the funding for the second supplementary budget was raised through expenditure restructuring, but for the third budget, the issuance of deficit-financing bonds will be unavoidable.
That said, KTB purchases by the BOK will likely absorb the new supply. The BOK’s recent decision to provide loans to non-banking financial firms highlights its willingness to deliver direct liquidity to the market. For the time being, KTB yields, especially long-term yields, will likely fall further.