[비즈한국] On the 14th, the KOSPI plunged again. As tensions in the Middle East escalated over the weekend, Brent crude oil futures surged to the $107 per barrel range early in Asian trading, causing major Asian stock markets to tremble. However, it is difficult to explain the market's movements solely through news from the Middle East. This is because a sharp rise in oil prices can stimulate U.S. inflation, and through expectations of interest rate hikes by the Federal Reserve and a rise in U.S. Treasury yields, it can also affect the flow of foreign capital.
The market is focusing on the Federal Reserve's interest rate decision, which will be announced early on the 17th, Korea time. Weight is being placed on the possibility of a 0.25 percentage point hike to the current benchmark rate of 3.50~3.75%. According to the CME FedWatch data reported by Reuters on the 14th, the probability of a hike is 86%. If the forecast holds, it would be the first increase in 3 years and 2 months since July 2023. However, stock, bond, and dollar directions may diverge depending on whether this hike is a one-off adjustment to address inflationary pressures or the beginning of a series of hikes.
The U.S. consumer price index for August rose 0.4% from the previous month and 3.4% from a year ago. Gasoline prices jumped 3.9% in one month, accounting for more than one-third of the total month-on-month rise in inflation. The core consumer price index, excluding food and energy, slowed to 2.4% year-on-year. However, the month-on-month increase rose from 0.2% in July to 0.3% in August.
If core inflation is in the 2% range, why is the Fed considering an interest rate hike? The inflation indicator the Fed officially targets is not the consumer price index, but the Personal Consumption Expenditures (PCE) price index. The total PCE inflation rate for July was 3.7% year-on-year, exceeding the 2% target. The core PCE inflation rate, which is valued when judging underlying inflationary trends, was also 3.3%.
An analysis of the 199 components of the PCE presented by Fed Chair Kevin Warsh at Jackson Hole last month also shows that inflationary pressures remain widespread. Prices for 54% of the components have risen by more than 3% over the past year. While it is true that gasoline pushed up August inflation, the inflation problem the Fed sees does not end with oil prices alone.
The Fed raising interest rates will not repair attacked oil pipelines or reopen the Strait of Hormuz. What should be guarded against through monetary policy is the process by which oil prices exceeding $100 per barrel spread to transportation costs, product prices, wages, and expected inflation. If it is a temporary supply shock, one might wait and see, but if it becomes a sustained inflationary pressure across the economy, the need for a response grows.
Employment is also not weak enough to stop a hike immediately. Non-farm payrolls increased by a preliminary estimate of 162,000 in August, and the unemployment rate remained at 4.1%. Inflation is higher than the target, but employment is holding firm. For the Fed, this is a combination that can be judged as having room left to suppress inflation further.
The argument for a hike already appeared at the last meeting. Although the Fed froze interest rates in July with a 9-to-3 vote, all three dissenting members argued for a 0.25 percentage point hike. According to the minutes of the July meeting, the financial market at the time was also reflecting one hike by September and another by the end of the first quarter of next year. This Federal Open Market Committee (FOMC) meeting is not a forum where the Fed will suddenly change direction, but rather a check on whether the hike argument, which was a minority at the last meeting, has risen to become the majority opinion following recent inflation and employment data.
The first thing to look at is the dot plot, which is released alongside the interest rate decision. In the June dot plot, 8 out of 18 members who submitted forecasts expected interest rates to be frozen until the end of the year. 3 suggested rates corresponding to one hike, and 5 suggested two hikes. One person anticipated three hikes, while another foresaw one cut.
When the forecasts were lined up from lowest to highest, the two middle values were 3.625% and 3.875%, respectively. The median year-end rate, averaging the two values, was 3.75%, and the chart displayed 3.8%, rounded to the first decimal place. However, not a single attendee actually proposed 3.75%. Therefore, we should not just look at the median value this time, but confirm in which direction and by how much the dots have moved. The dot plot is a collection of individual forecasts, including those from non-voting members, and is not a formal policy commitment by the Fed.
If they raise it by 0.25 percentage points this time, the benchmark rate range becomes 3.75~4.00%, with a midpoint of 3.875%. If the median year-end forecast is 3.9% (rounded), it corresponds to a path with no additional hikes until the end of the year after this one. If it is 4.1%, it corresponds to one additional hike within the year. However, it cannot be concluded that the majority of attendees expect exactly the same path based solely on the median value. One must look at the distribution of the dots and the forecasts for next year together.
The second is Chair Warsh’s press conference. Last month at Jackson Hole, he assessed that there are few signs of policy constraints in the credit and loan markets, stating that it is difficult to call overall financial conditions "tight." It is important to see how he evaluates financial conditions and the inflation outlook after this hike, and how much he emphasizes the need for additional measures.
The third is the market’s reaction to the Fed’s words. According to Fed statistics, on the 10th, the U.S. 10-year Treasury yield was 4.95% and the 30-year yield was 5.37%. While the Fed sets the benchmark rate, long-term rates also have a major impact on mortgage loans, long-term corporate financing costs, and the valuation of growth stocks.
If the 10-year yield falls even though the Fed raised rates, it could be interpreted that the risk of further tightening has decreased. Conversely, if benchmark rates and long-term rates rise together, it could be a signal that concerns about further hikes or long-term inflation remain. However, long-term rates reflect not only inflation but also growth prospects, fiscal deficits, government bond supply, and demand for safe-haven assets. One must also examine the possibility that a drop in rates stems from concerns about an economic slowdown. It is necessary to check changes in 2-year yields, which are sensitive to policy rate forecasts, and interest rate futures.
Long-term bond investors do not need to rush and think, "Rates have been raised, so now I should buy bonds." Long-term bonds are a means to secure interest income, but the longer the maturity, the greater the price fluctuation in response to changes in market interest rates. In particular, if you sell before maturity or invest in long-term bond funds/ETFs, you must consider valuation losses resulting from rising interest rates. While checking the dot plot and market rate reactions, one can consider diversifying maturities and entry points to fit their investment objectives.
Stock investors should look at the direction and reason behind the movement of long-term rates rather than chasing the first move of the index immediately after the announcement. Growth stocks with a high proportion of future profits and REITs with high borrowing burdens are sensitive to rising long-term rates. One should not look only at dividend yields for high-dividend stocks either. In an environment where the U.S. 10-year Treasury yield is nearing 5%, the sustainability and growth potential of dividends become even more important. However, when comparing won-denominated assets and U.S. Treasuries, one must also consider exchange rates, currency hedging costs, and taxes.
The KRW/USD exchange rate rose to 1,555.8 won as of the 3:30 PM closing price on July 2nd, but has since fallen to the mid-1,300 won range this month. Investors who bought dollars when the exchange rate was high may have seen their won-denominated value shrink even if the dollar-based price of U.S. assets remained the same, provided they did not hedge their currency. However, one should not conclude that this hike is a signal of a dollar rebound. If the outlook for additional hikes weakens, the dollar could actually fall.
Supply instability from the Middle East and concerns over U.S. tightening are simultaneously pressuring the market. If this hike is largely reflected in expectations, the key is the path that follows, rather than the hike itself. What the market will re-price is the possibility of additional hikes that the dot plot and Warsh’s remarks will reveal.