KTB Yields Expected to Continue Downtrend
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
At the upcoming July meeting, the Fed will likely raise the FF rate by 75bp and signal for at least a 50bp hike in September, when the QT threshold will also be doubled. Last week, the ECB enacted a surprise 50bp hike, further fueling the reverse currency war. Headwinds against global growth are to persist.
Fed to reaffirm intention to control inflation with 75bp hike
We expect a 75bp hike at the upcoming July FOMC. Also, Chair Powell will likely reaffirm that the Fed’s most important goal is to fight inflation and signal for a rate hike of at least 50bp in September. As the QT schedule is unlikely to change from the May plan, the scale of QT should double from September.
On another note, inflation peak-out claims are mounting based on the recent price drop for major commodities. We believe that inflation will fall from 3Q22, which should shift market attention from inflation to stagnating growth. However, as the Fed’s current strategy is to stay behind the curve, the inflation outlook has little implication for the Fed’s policy outlook. In our view, the Fed will adhere to its tightening drive until the inflation trajectory shows a clear decline. We note that this intentional policy failure induced by the Fed has been the key driver of the recent plunge in inflation expectations. We expect the Fed to maintain course for now.
Elsewhere, the ECB hiked its three key rates by 50bp each last week, and the BOE’s Governor Bailey mentioned the possibility of a 50bp hike in August. Not only DM but also EM economies are taking part in this hike cycle, with 22 out of 47 countries having raised their benchmark rates in June. A reverse currency war is effectively taking place, with countries worldwide attempting to export inflationary pressure to others—a situation that will likely result in strong headwinds against global economic growth in 4Q22. Of note, July composite PMI for the US and eurozone both fell below 50. The chance of policy failure is to feature as the main theme of the 3Q22 TB market, pushing long-term TB yields to stabilize downward.
BOK’s role during reverse currency war
A global recession is gradually becoming consensus. As the Korean economy is determined mainly by external factors (foreign demand and commodities prices) rather than internal ones, concerns over a slowdown in major economies should shift the KTB market’s focus from inflation to economic growth.
Moving ahead, inflation-related worries are to begin to ease. Since 2021, 10yr KTB yield has closely matched the WTI price converted to won (correlation coefficient of 0.95). In addition to the downward stabilization in the won-converted WTI price since mid-June, US refining margins have also peaked out. Against this backdrop, we expect KTB yields to continue their downtrend.