Possibility of 2 Hikes by Yearend Cannot Be Ruled out
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
In addition to Governor Lee Ju-yeol alluding to a key rate hike by yearend, the MOEF seems to accept the possibility of a rate hike. Also, the possibility of two hikes by yearend cannot be ruled out. Noting the tightening effect of a rate hike and a reduction in KTB issuance, we continue to recommend buying 10y KTBs.
Economic duress possible even if financial conditions are not tightened
BOK Governor Lee Ju-yeol clearly suggested a rate hike by yearend at the price stabilization target press conference last week. The governor stressed that the 2020 rate cut was aimed at responding to the unprecedented events of Covid-19, and thus reversing the cut does not mean financial tightening. Even with one or two hikes, the key rate would return to a ‘neutral’ level from the current overly eased level.
In addition to the governor’s remarks, Deputy Prime Minister Hong Nam-ki last week expressed a favorable view for a rate hike, noting that the extra budget and a rate hike were not contradictory. Also, Yoon Hoo-deok, chairman of the Strategy and Finance Committee, highlighted that raising the base rate is normalization, not tightening. Our base scenario is for an October hike followed by another hike after the 2022 presidential election. However, noting the financial authorities’ support for a rate hike ahead of a large-scale supplementary budget, if two minority opinions for a rate hike arise at the July MPC meeting, two hikes could be possible by yearend. In such a case, a rate hike in 2022 would not be easy, given the downward revision to the 2022 growth forecast. We maintain our forecast for an end-2022 key rate of 1%.
We continue to recommend buying 10y KTBs. Judging whether a rate hike will make financial conditions tight is a different matter from determining the tightening effects of a rate hike on the economy. In 1Q21, domestic interest-bearing debt recorded W3,926tn, meaning a rate hike will reduce spending capacity by about W9.81tn. Although one or two rate hikes will not make financial conditions tight, it will slow down the pace of economic recovery. Noting this, 10yr KTB yield should price in a fall in term premium despite higher expectations for a BOK rate hike.
Moreover, non-competitive issuance recorded W3.5tn in June. Assuming that it remains the same in July, average monthly KTB issuance from August will decline by W5.5tn compared to the average issuance over January~July. Supply-demand conditions should become increasingly favorable towards yearend.
US TB yields taking a breather
Recently, a few FOMC participants have reiterated their support for a 2022 FF rate hike. However, as seven members already voted for a 2022 rate hike in the June FOMC dot plot, we view that nothing has changed. Rather, inflation expectations have rapidly fallen since the June FOMC meeting, and May real and nominal personal consumption came in below consensus. In our view, US TB yields are taking a breather before the end of unemployment benefits accelerate the recovery of employment indicators.