DPM Hong Announces Additional Budget of KRW14tn
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
Fed QT is likely to increase the TB 10yr term-premium by 37.5bp. Noting this, if the FF rate is hiked four times this year, then QT will have to be increased further to prevent a long-short TB yield spread reversal. With this in mind, we expect the Fed to adjust its number of rate hikes and level of QT as needed.
Fed’s options: 1) significantly increase the size of QT; or 2) use both QT and rate hikes
The Fed is calling on the US TB market to price in a March FF rate hike in order for quantitative tightening (QT) to be implemented in 2H21 (rate hikes are a prerequisite for QT). Currently, one of Fed’s biggest concerns in policy normalization is the long-short TB yield spread. The 10yr-2yr spread currently stands at the 3Q17 level (when the Fed announced QT following several rounds of rate hikes), while the 30yr-10yr spread matches the end-2017 level. In other words, rapid FF rate hikes could cause the already low long-short spread to invert.
In May 2021, the New York Fed presented its future Fed asset to GDP outlook. Using the CBO’s GDP outlook, we estimate that the Fed’s current plan aims to cut US$1.05tn in assets in the first year of QT. When the Fed announced QT in 2017, it estimated that 2018 QT (US$373bn) would increase 10yr term-premium by 14bp. Taken together, the Fed is aiming to increase 10yr term-premium by around 37.5bp this time.
However, rate hike bets have risen significantly since May 2021, a time when no hikes were reflected for 2022. This means the existing QT plan alone cannot offset concerns over long-short spread inversion. Should the Fed hike the FF rate four times, as expected by the market, it would have to significantly expand its level of QT, which we believe is unlikely. Rather, we view that the Fed will adjust both the number of rate hikes and level of QT as needed.
Supplementary budget earlier than expected; still no need to rush
Last week, Deputy Prime Minister Hong Nam-ki announced an additional budget of W14tn. Although excess tax revenue totals around W10tn, it cannot be earmarked until the budget settlement process finishes in April. As such, deficit-financing KTBs will be issued for now. What is positive is that the deficit-financing KTBs will be distributed equally over the coming months and can be repaid through excess tax. However, given the earlier-than-expected announcement, it is inevitable that KTB market participants will be concerned over additional supplementary budgets after the presidential election.
Listed companies’ OP growth likely reached 65% y-y in 2021. This means that corporate taxes will rise significantly in 2022. As such, the burden of deficit-financing bonds from additional government spending is unlikely to be heavy this year. That said, we expect the KTB market to react more sensitively to government spending issues ahead of election. In our view, there is no need to hurry into KTB dip-buying at this juncture.