FOMC Meeting to See 25bp FF Hike and Caution over Further Hikes
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
Currently, with supply-side inflation strongly constricting economic growth, the Fed will likely be cautious with rate hikes. In addition, due to geopolitical risks, a supply-demand mismatch in the US short-term financing market is intensifying. Discussions on QT will likely be elementary at the upcoming meeting.
FOMC meeting to see 25bp FF hike and caution over further hikes
The BOE and ECB have already raised their inflation forecasts and lowered their GDP growth forecasts. The Fed will likely follow suit, raising its inflation outlook and slightly lowering growth expectations. DM central banks face the dilemma of implementing tightening policies in the face of rising inflation constricting demand.
High inflation needs monetary tightening, while weak growth needs monetary easing. We note that demand-side inflation needs to be managed through monetary tightening, but supply-side inflation itself has the effect of tightening. Supply-side inflation significantly increases living costs, which has the effect of lowering disposable income and putting strong downward pressure on real wages. Noting San Francisco and New York Fed data, the recent uptick in inflation is still largely attributable to supply-side factors. As such, the US economy is already under strong tightening pressure from supply-side inflation. Thus, monetary authorities will have little choice but to be cautious with policy normalization.
We expect the Fed to enact a 25bp FF hike at the upcoming March FOMC meeting and signal that further hikes will take place, but emphasize a data dependent approach rather than aggressive path of normalization. On the issue of quantitative tightening (QT), short-term financing issues will likely bar the Fed from having detailed discussions. Due to recent geopolitical risks, demand for securing cash has resulted in a simultaneous surge in 3M CP yield and the Libor-OIS spread. Although the liquidity issue is not yet severe, QT surprises could worsen the mismatch in the short-term funding market. In our view, the March FOMC meeting will mark the beginning of a policy normalization cycle, but the overall tone will be cautious rather than aggressive.
Prioritizing expenditure adjustment will lower supply burden
According to an interview of Professor Kim So-young, an economic advisor for President-elect Yoon Seok-yeol, small business support will total W43tn, of which W30tn will be financed by expenditure cuts and W13tn by excess tax, extra funds, and reserves. On the latter, W5.48tn has already been rolled over from last year’s budget. Noting the surge in corporate OP in 2021, this year’s tax revenue should sufficiently fill the remaining W7.52tn. As such, the actual issuance of deficit government bonds should be limited. With the president-elect’s priority to enact expenditure cuts, supply-demand burden in the KTB market should greatly ease.