Recession Fears Hard to Dispel
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
The biggest concern of US TB market is whether the unemployment rate will fall further even with aggressive monetary tightening efforts underway. Chair Powell has refrained from giving a clear answer, instead pointing to the possibility of a temporary rise in the potential unemployment rate. Given this backdrop, concerns towards an economic hard-landing are to persist for now.
Implications of Powell’s ambiguous tone on employment
Inflation surprise has been a key component of the TB yield surge seen since early-2022. But despite an April CPI surprise, long-term US yields fell sharply last week. This suggests a change in the TB market’s response function to inflation, attributable to the market’s distrust in the Fed’s ability to achieve both an economic soft landing and inflation control (ie, policy failure betting).
Markets are not feeling reassured by Chair Powell’s claim that US economy is ‘far from stagflation’ because of his ambiguous interpretation of the labor market. Powell has consistently argued that a recession is unlikely as current employment indicators are strong. But, we point out that the unemployment rate is a lagging indicator. The Fed has begun an aggressive tightening cycle amid unemployment falling to its lowest point since 1960, raising questions on whether it can drop further. Of note, Powell has added to market confusion by mentioning at the March FOMC that potential unemployment rate could temporarily rise higher. Recession fears will likely be hard to dispel for now.
Despite the April CPI surprise, we note that: 1) growth rate fell slightly from its March high; and 2) inflation growth profile shifted from commodities to services-based, which is more sensitive to Fed policies. Moving ahead, we expect market attention to shift gradually from inflation to economic growth.
KTB supply-demand conditions to be more favorable towards yearend
The government has announced that there will be no additional KTB issuance for a second supplementary budget. And, excess tax of W9tn is to be used for KTB repayment, which could be increased up to W12tn. With worries over further issuance ended up as repayment, market sentiment has improved.
The government’s planned KTB issuance amount is W177.3tn, including W11.3tn for the first supplementary budget. By May, 49% (W87.1tn) of the issuance was fulfilled via competitive bidding. If including non-competitive bidding volume, more than half of total issuance will have been issued by May. Thus, even without additional repayment, average monthly issuance will have been reduced by W4.5tn from June. Noting the repayment, we estimate that monthly average issuance will fall by W6.3tn in 2H22. Looking at supply-demand conditions, we expect the KTB yield downtrend to continue for now.