Too Early to Buy Long-term KTBs Based on Price Merit
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
In a recent speech, Jerome Powell noted that: 1) employment is more important than inflation; and 2) vaccinations do not mean central bank tapering. Long-term TB yields will likely overshoot as efforts are made to induce a high-pressure economy. As such, we believe that it is still too early to invest in long-term bonds.
Central bank presence needed even after wartime
Disputes over inflation are a focus both in and out of the Fed. 10yr BEI has expanded to 2.22% on expectations of massive fiscal spending, and 5yr inflation swap rates, which act as a barometer for mid-term expected inflation, have also expanded to 2.4%. However, during the holidays, Jerome Powell’s speech on getting back to a strong labor market suggests that: 1) the Fed’s current policy focus is on employment rather than inflation; and 2) vaccines do not signal central bank tapering.
In his conclusion, Powell said that the Employment Act (1946), enacted after World War II in the run-up to the reemployment of millions of workers and massive economic restructuring, was the basis for the Fed’s full employment obligation. Powell also emphasized that Fed members are strongly committed to doing all they can to promote this employment goal. This message shows that: 1) full employment objectives trump the stable prices mandate for now; and 2) central bank influence is needed not only during wartime, but also in post-war periods.
This is in line with the monetary policy assumptions we made in our annual outlook. The Fed will likely implement monetary policy to induce a high-pressure economy to cement full employment. However, the central bank is likely to intervene again at a critical point where nominal yield spikes constrain the economy. In other words, if real yields begin to rise, we expect the Fed to intervene. We still predict overshooting of long-term US TB yields over March~April to as high as 1.50%. We maintain our recommendation of underweighting US TBs.
Discussion on fourth disaster relief fund after Lunar New Year holidays
Shortly before Lunar New Year, Kim Yong-beom, the vice minister of MOEF, announced that he will begin formal discussions on a fourth disaster relief fund with political parties, MOEF, and the presidential office. With the government mentioning that the supplementary budget will be ‘as big as can be afforded by national finances’, uncertainties related to bond supply/demand are likely to ease somewhat once the scale of the extra budget is disclosed in late-February.
However, due to the unexpected supplementary budget in 1Q21, the fiscal spending contribution to GDP growth will likely exceed expectations. Noting strong export indicators, the possibility of 1Q21 GDP growth is rising. At a time when US TB yield upward pressure is mounting, we believe that it is too early to buy long-term KTBs based on price merit.