Fixed Income Weekly: beware of circular reasoning

The author is an analyst at NH Investment & Securities. He can be reached at [email protected] — Ed.

Amid recession fears, the US TB market expects the Fed to proceed with less aggressive monetary tightening. However, weaker monetary tightening will lead to higher inflation expectations. We caution against circular reasoning. We also think the BOK will continue to focus on fighting inflation for now, with a 50bp rate hike likely at its next meeting.

Beware of circular reasoning

As major commodity prices and inflation expectations tumbled on recession fears, expectations of peak inflation were highlighted, lowering bets on aggressive Fed tightening . However, we note that weaker monetary tightening will raise inflation expectations. Therefore, we caution against such circular reasoning.

At the May FOMC meeting, Jerome Powell said he would not accept ambiguous interpretations of the path of prices and insisted on “clear and convincing” signs that inflation was fading. In other words, the Fed won’t preemptively change its pace of tightening based solely on expectations of a spike in inflation, and if there are side effects to aggressive tightening, the Fed will deal with them at a later date. Currently, the US central bank follows the principle of data dependency.

Given the continued rise in gasoline prices, the June CPI (to be announced this week) is likely to remain elevated. So, for the Fed to verify the “clear and convincing” signs of an end to the peak in inflation, we will have to wait for inflation data from July to August. It is too early to expect a change in the pace of Fed tightening.


The June nonfarm payrolls report also supports aggressive Fed tightening. Despite recent signs of economic slowdown, employment has held up. This means that the Fed can focus more on its fight against inflation than on the economy. Concerns about policy failure will be hard to dispel and we expect the US 10y-2yr TB spread to remain in negative territory for now.

Expect a 50bps rate hike at July BOK meeting

As Korea also grapples with rising inflation, we expect the BOK to unanimously decide on a 50 basis point hike at the next meeting in July. Of note, consumer inflation expectations jumped to 3.9% in June, with real CPI growth hitting 6%. The Fed is also likely to raise the FF rate by another 75 basis points in July, which means that all the conditions are in place for a significant rise in the BOK.

Amid the possibility of a Fed policy failure, KTB’s market attention focused on the magnitude and number of additional BOK rate hikes after July. As the BOK is still battling inflation, we expect an additional 25bps hike in August. However, the hard data slowdown will likely accelerate in 3Q22 and GDP growth is expected to fall below potential growth in 2023. Thus, the BOK’s focus is likely to shift from inflation to stagnation in 4Q22. We are therefore maintaining our end-of-year base rate forecast at 2.50%.

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