Controlling Inflation Expectations Is Important
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
US PMI, the copper/gold ratio, and Korean exports are all displaying signs of weakening demand. However, central banks, which are sticking to their ‘behind the curve’ approach to inflation, will continue their tightening drive. Aggressive tightening amid weakening demand will lead to TB curve flattening.
Aggressive Fed tightening coinciding with weakening demand
Our central view on the US TB market for 2H22 is that the focus will shift from inflation to growth as the Fed will enact aggressive tightening even at the risk of a recession. Of note, last week, Jerome Powell said there was a clear possibility of a recession and the New York Fed estimated the possibility of a hard landing at 80%.
We are already seeing signs of weakening demand. US June manufacturing PMI recorded 52.4p last week, the third largest m-m drop. We also note that production and new orders indices fell below the baseline (50p) and the level seen in 2H19 (last late cycle before Covid-19). Corporate sentiment is quickly deteriorating from the aggressive Fed tightening and rising costs. Employment PMI will likely fall further as the Fed declared that it will act to dampen labor demand.
In addition, the overall commodities market fell significantly last week on concerns over weak demand. Of note, the copper/gold ratio, which is known to best match the 10yr TB yield trend, also plunged.
Will the Fed tone down its hawkishness with these signs of weaker demand? It is unlikely, as inflation expectations have rebounded every time the market has expected the Fed to ease tightening. The Fed sees no option but to continue its aggressive tightening stance until inflation growth clearly wanes. As aggressive tightening and weakening demand are occurring simultaneously, we expect yield curve flattening pressure to sustain.
Signals in Korean exports
Average daily export growth in June (estimated based on data till Jun 20) will likely fall to the single digits for the first time since Feb 2021. Nominal amount will also be around W2.5bn, an important benchmark. Average daily export growth will likely be negative in 4Q22, leading the BOK to lower its GDP growth forecast significantly, as the Fed did at the June FOMC meeting.
In the domestic market, controlling inflation expectations is important, despite mounting recessionary fears. Therefore, a big rate hike (50bp) in July and another hike (25bp) in August seem inevitable. Korea is also undergoing a period of economic slowdown coupled with aggressive tightening. Once inflation expectations are dealt with, we believe that the market’s focus will quickly shift to slowing economic growth.