Fixed Income Weekly: central bank arbitration between inflation and recession

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

We expect a 75 basis point hike at the next FOMC in September and another 50 basis point hike in November. The BOE will also adopt a 50 basis point hike. The common message from global central banks is a willingness to trade inflation for recession. For now, both the inversion of the 10yr-2yr yield spread and real yields are likely to rise further.

Central banks trade inflation for recession

Ahead of the September FOMC, the August CPI shows that the inflation peak is still uncertain. A 75bp hike seems inevitable, and the Fed will likely signal that a more than 50bp hike will follow in November. As such, we are raising our year-end FF rate forecast to 4%. The likely discussion of MBS sales by the FOMC committee is expected to appear in the minutes, which will be released later.

The September meeting aims to probe the meaning of “higher for longer”, ie: 1) where the terminal rate is (higher); and 2) how long the FF rate will stay there (longer). Given the annual inflation forecast of 4.1% for 2023, we believe that the Fed’s main objective is to exceed 4%, as the terminal rate is generally set above inflation. As such, we expect the dot plot to show an end of the up cycle at 4.25% in 2023.

The question of how long high rates will persist is tied to when the Fed begins its rate-cutting cycle. Market expectations for rate cuts are mitigating the effects of the tightening. So Chairman Powell should signal that rates will hold for some time after the last hike. The message from the Jackson Hole Symposium to focus on controlling inflation even at the expense of recession is likely to be repeated.


Additionally, the UK, which is expected to experience negative growth throughout 2023, is expected to rise 50 basis points this week. The common theme of central banks in emerging countries is to trade high inflation for recession. The 10yr-2yr and 10yr-5yr real spreads are currently inverted, and the New York Fed’s 10yr-2yr economic factor spread has inverted for the first time since 2007. Inverted again.

KTB 10-3yr yield reversed for the first time since 2008

Looking at the growing diversion between the WTI price converted into won and the KTB 10-year yield, we suggest that the rise in the KTB yield was caused by fear of Fed tightening rather than fear. of inflation. The BOK is also affected by the Fed’s inflation control in exchange for the recession. It should be noted that the KTB 10yr-3yr spread has reversed for the first time since the 2008 financial crisis. Although its economic momentum is weaker than that of the United States, Korea will be forced to share the cost of Fed tightening. We expect the KTB 10y-3y reversal to deepen.

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