April FOMC to Review Rather Than Implement Policy
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
The upcoming April FOMC meeting is shaping up to be relatively neutral, primarily aimed at checking the effectiveness of policies put into place from March. However, an IOER rate hike is possible. Due to the Korean government’s aggressive fiscal policy, KTB issuance will likely surge. Accordingly, the BOK’s KTB purchases are to play a critical role in stabilizing the KTB market.
April FOMC to review rather than implement policy
The upcoming April FOMC meeting is shaping up to be relatively neutral, primarily focused on reviewing the effectiveness of rate cuts, QE, and credit policies implemented since March. However, there is the possibility of a 5bp IOER rate hike, considering that repo rates have remained within negative (-) territory as of late. Of note, the Fed has already begun slowing its QE-related purchasing. On Mar 23, when the Fed announced unlimited QE, KTB and MBS purchases totaled US$75bn and US$50bn, respectively. Beginning this week, purchasing has dropped to US$10bn and US$8bn, respectively.
We attribute the Fed’s deceleration to the effectiveness of its recent policies. The Libor-OIS spread has narrowed from 138bp to 81bp, and prime MMFs (which triggered a massive selling of CPs) have seen a significant influx of funds. Thus, it appears that the Fed has effectively dealt with the immediate crisis.
However, we urge caution in interpreting the April FOMC meeting as representing a transition into tightening, as the IOER rate is merely a technical mechanism for coaxing the effective FF rate into the median range of the FF target rate. Moreover, we estimate that the Fed currently has a maximum of US$2tn available for additional credit policy and expect the Fed to emphasize its ability to carry out further easing. Thus, even with the Fed decelerating, US TB yields should continue to trade within a stable range.
Meaning of government guarantees: To enable BOK purchasing
Last week, the government announced plans for a W40tn relief fund for key industries and a W9.3tn job protection scheme. The key industries relief fund is to be financed via specialized banks’ bonds, while the third supplementary budget (includes jobs scheme) is to be financed mainly via debt-financing treasury bonds.
With the third supplementary budget estimated at around W20tn and around W40tn in specialized banks’ bonds expected to be issued, the KTB market is likely to see immense supply pressure. We note that similar developments occurred during the IMF crisis, when: 1) long-term KTB issuance soared; and 2) a total of W86.7tn in KAMCO and KDIC bonds were issued. At the time, even amid economic slowdown, supply burden pushed yields upwards.
Due to supply burden, the 10yr-3yr spread has widened to levels seen during the 2017~2018 rate hike cycle—the prerequisite for active KTB purchasing given by Governor Lee at the April MPC meeting. Also, the government has announced plans to provide guarantees for specialized banks’ bonds. According to the Bank of Korea Act, marketable securities with government guarantees are eligible for BOK purchase. With the government creating room for BOK purchasing of the upcoming issuances, the BOK’s role as a buyer looks set to strengthen.