Concerns over US Recession to Grow Regardless of July Rate Hike
The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. -- Ed.
Concerns over US recession to grow regardless of July rate hike
The market’s focus is back on US monetary policies. The Consumer Price Index (CPI) in the US rose 9.1% YoY in June, marking the largest increase reported since December 1981. The Bank of Canada raised its key interest rate by a full percentage point at the latest policy meeting, adding to growing expectations for a 100bp Fed rate hike at the upcoming FOMC meeting in July. According to CME Group data, the probability of a 100bp rate hike jumped to highs of 80% before falling back to the 43% range in one day following skeptical remarks by Fed Governor Christopher Waller on July 14. The figure, however, still remains at relatively high levels.
While the market continues to contemplate the probability of a super-sized rate hike, we believe whether the US Fed decides to raise rates by 75bp or 100bp at the July FOMC meeting will make little difference to bond market conditions apart from the extent of recession worries. The US bond market is already pricing in recession expectations, with recession probabilities estimated with 10Y-3M yield spreads on the rise this month from previous 3-4% levels to highs in the 14% range at present.
Meanwhile, the US Fed remains more focused on the near-term forward spread (compares the expected 3-month interest rate 18 months from now with the current 3M Treasury yield) than on 10Y-2Y or 10Y-3M yield spreads. The figure increased up to 270bp in late March, the highest seen since the data was first published in April 1996, justifying the Fed’s confidence in a soft landing. However, the spread soon shifted to a steep downtrend and is currently below 80bp levels. If the near-term forward spread falls to zero or below, indicating heightened fears of recession, expectations will grow for a shift in monetary policy stance of the US Fed. At home, market volatility should decline somewhat with the US Fed in a blackout period and no major economic indices scheduled for release. This week, we expect a yield band of 3.18-3.32% for 3Y KTBs and 3.23-3.40% for 10Y KTBs. The 3Y-10Y yield spread should move within 5-8bp.