Korea’s Annual Average CPI Growth Projected to Reach 3.4%
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
Based on the US government’s interest expense-to-fiscal debt ratio, we believe that the US can tolerate 10yr TB yields of up to 2.75%. US TB yields are unlikely to keep trending upwards. With regards to BOK monetary policy, we raise our outlook on the number of additional rate hikes (from one to two by yearend) noting the March inflation surprise.
US government can withstand 10yr TB yields of up to 2.75%
The March FOMC meeting minutes suggest that the May meeting will entail a 50bp FF rate hike and the implementation of quantitative tightening (QT). As such, we expect 125bp in hikes by yearend (June, July, and September), including a 50bp hike in May.
The key points of the upcoming QT are: 1) T-bills will also be included in the program; and 2) MBSs may be sold. In the last QT cycle, when the amount of TBs reaching maturity fell below the monthly cap, the balance sheet was reduced by that amount only. This time around, the Fed plans to max out the run-off amount by filling up the shortfall with T-bills. In other words, the Fed has signaled a strong commitment to reducing liquidity. In addition, it said that it would be appropriate to sell MBSs in due time. Already, 30yr mortgage rates have risen above their previous peak in 2018. We believe that the Fed is targeting the asset market in order to curb inflation.
The Fed’s aggressive QT signals have sent long-term yields soaring again. We can deduce the high point of US TB yields from a fiscal point of view by estimating the level of TB yields that the US government can withstand. Since 1960, the US government’s interest spending-to-fiscal debt ratio has served as a ceiling for 10yr TB yield. Interest spending-to-GDP ratio was highest in 1991 at 3.2%, at which time the Bush administration was pressured into withdrawing its tax cut policy. We estimate that interest spending of US$800bn will raise the ratio back to 3.2%. Drawing on the White House’s debt estimate, this year’s interest expenditure-to-debt ratio is around 2.55%. As the 1Q22 average 10yr TB yield was 1.97%, we estimate a high of 2.75% for 10yr TB yields.
MPC to keep rate frozen in April; yearend BOK rate rasied to 1.75%
We expect the BOK to freeze the benchmark rate at the upcoming April MPC meeting, noting: 1) the absence of a BOK chair and the government transition period; and 2) the fact that the next FOMC meeting is in early May, which reduces the need for a BOK rate hike. However, there may be a minority opinion for a rate hike.
With March CPI inflation hitting 4.1%, we predict that Korea’s annual average CPI growth will reach 3.4%. We have been arguing that it will be difficult for the BOK to hike the base rate in May, as the BOK will be lowering its GDP growth forecast. However, given the April inflation surprise, we expect the BOK to raise its inflation forecast in May (previously 3.1%) and the Fed to enact a 50bp hike in May. Accordingly, we change the number of additional BOK rate hikes through yearend from one to two (in May and 3Q22), giving us a yearend benchmark rate of 1.75%.