Daily Breakfast Spread
DBS Group Research11 Aug 2010
Greater China, Korea
The Bank of Korea will meet tomorrow morning to review monetary policy. It iswidely known that the BOK will continue normalizing policy after raising thebenchmark repo rate by 25bps in July (the first hike since the global crisis), but thepace of interest rate normalization remains a question. In our view, the BOK is likelyto keep rates unchanged at 2.25% on tomorrow’s meeting before moving again inSeptember. The BOK meeting is scheduled on a frequent (monthly) basis. Back-to-back rate hikes will quickly push up the repo rate to 4% in the beginning of nextyear and 5% (the precrisis neutral level) in mid-2011. With uncertainties stilllingering in the global economy (such as US growth sustainability and Chinaslowdown), the BOK would be inclined to normalize policy in a gradual manner toavoid the risks of derailing economic recovery.On the data front, the Korean economy continued to grow but the growth ratemoderated slightly in 3Q. Exports decelerated to 29.6% YoY in July from 30.1% inJune (a modest 0.3% MoM sa). Business sentiment in the manufacturing industryimproved marginally to 109 (sa) in August from 108 in July. Consumer confidencestayed unchanged at 112 in July, the same level as in the previous month.Meanwhile, inflation remained stable, both for the headline CPI (2.6% YoY in July)and core CPI (1.7%). Residential property prices have retreated, falling on MoM basisfor the first time over 16 months (-0.2% in July). By any measure, policymakers arenot under great pressure to hike rates at the current juncture. Our year-end targetfor the repo rate is maintained at 3.0%, and the 12-month target is 4.0%.
: The Fed shifted policy back to a strictly neutral stance yesterday, announcingthat it would reinvest proceeds from maturing MBS (housing) securities into longer-term government bonds. The shift was a symbolic one: maturing proceeds of some$130bn over the coming year would, if not reinvested, have shrunk the Fed’sbalance sheet by about 5%. That’s too small an amount to have a “fundamental”impact on rates or economic activity. Short-term rates, currently at or near zero,would have been unaffected by the move, absent a separate and explicit policymove to change them. Longer-term rates such as 10Y Treasury yields (chart below),have run the gamut between 4.00% and 2.15% anyway, with little or no change inFed balance sheet size.
US Fed expectations
Source: Bloomberg fed fundfuturesNotes: Given a FF target rate of0.25%, an implied FF rate of0.30 is interpreted roughly asthe market pricing in a 20%chance of a Fed hike to 0.50%from 0.25% (30 is 1/5th of thedistance to 50 from 25). DBSexpectations are presented indiscrete blocks of 25bps, i.e., theFed moves or it does not. Seealso “Policy rate forecasts”below.
Implied fed funds rateSep-10Dec-10Mar-11
8 A u g 0 7 2 5 J u n 0 8 3 1 D e c 0 8 2 8 J a n 0 9 2 5 F e b 0 9 2 5 M a r 0 9 2 0 M a y 0 9 1 5 J u l 0 9 9 S e p 0 9 1 4 O c t 0 9 1 1 N o v 0 9 9 D e c 0 9 6 J a n 1 0 3 F e b 1 0 3 M a r 1 0 3 1 M a r 1 0 2 8 A p r 1 0 2 6 M a y 1 0 2 3 J u n 1 0 2 1 J u l 1 0
US Fed balance sheet and 10Y UST yields
USD bn, nsaFed balance sheet size%10Y UST yields