Bank of Korea Foreign Exchange Operations Department
Recent Evaluation and Outlook on the Decline in US Treasury Yields
[Asia Economy Reporter Kim Eunbyeol] Is the Federal Reserve's (Fed) claim that "inflation is temporary" gaining traction? Despite the U.S. consumer price inflation rate rising more than expected, the market impact has been limited, leading to assessments that the Fed's possibility of early monetary policy normalization has decreased.
Despite higher-than-expected inflation, the stock market is actually rising, and market interest rates are falling (bond prices rising), showing a trend contrary to the usual expectations. Although inflation surged in May, it was at the anticipated level, and due to the base effect from last year's COVID-19 crisis, there is an expectation that inflation will calm down from the second half of the year.
On the 14th, the International Finance Center released a report titled "Reasons for Limited Market Impact Despite Continued Strength in U.S. Consumer Price Index (CPI)," stating, "Although the U.S. CPI showed strength for two consecutive months, the financial market response was limited," and evaluated that "market participants largely accept the view that the inflation surge is temporary and have accepted the Fed's policy framework shift that prioritizes employment over inflation."
In May, the U.S. CPI rose 0.6% month-on-month and 5.0% year-on-year, significantly exceeding expectations. The U.S. 10-year Treasury yield rose about 3 basis points (1bp = 0.01 percentage point) immediately after the CPI release but then fell to 1.43%, the lowest since March 2 (1.39%). It has been moving around 1.46% on the same day. The 10-year breakeven inflation rate (BEI) also dropped from 2.56% on the 17th of last month to the 2.35% range. The 10-year Korean government bond yield also remains around 2.094%, showing no significant rise above the 2% level. The KOSPI index continues its upward trend.
Kim Sungtaek, head of the Global Economy Department at the International Finance Center, said, "As seen in the weakening BEI, the recent financial market generally accepts the Fed's assessment that inflation caused by demand-supply mismatches is temporary and somewhat downplays the possibility that the inflation trend will be persistent."
The Bank of Korea's foreign exchange operations team also stated in "Evaluation and Outlook on Recent U.S. Treasury Yield Decline" that "the market is paying more attention to the underwhelming employment recovery, and with the decline in expected inflation, the Fed's claim that inflation is temporary is gaining some credibility." The May nonfarm payrolls released on the 4th showed 559,000 jobs added, significantly below the expected 675,000. Unless the inflation surge continues, there is growing support for the view that the Fed will focus more on employment recovery than inflation and maintain accommodative monetary policy.
Bloomberg reported that investors who had sold government bonds expecting inflation have closed their short positions. This is because expectations for early Fed monetary policy normalization have diminished. As of the 17th of last month, the market expected the Fed to raise rates 0.2 times next year, but by the 11th of this month, experts expected zero rate hikes next year.
Domestic market experts also explained that the perception that the May inflation rate has effectively peaked on an annual basis is reflected. Gong Dongrak, a researcher at Daishin Securities, said that while the absolute value of future inflation data might still be considerable, there is an expectation that it will be lower than in May. The BEI, which reflects market expectations of future inflation trends in the bond market, showed signs of decline since mid-May. This may be a preemptive response to the May inflation peak theory formed after the April inflation shock.
Looking at inflation indicators by item, the fact that only some items surged sharply also supports the argument that the inflation rebound is temporary. Excluding highly volatile items among the inflation index components, inflation still does not significantly deviate from a limited range. A representative example is the price of used cars and trucks, which explains about half of the core CPI increase, rising 7.3% month-on-month. Clothing (1.2%) and transportation services (1.5%) also showed steady increases.
The International Finance Center stated, "Although inflation indicators surged, the market is responding calmly, so attention should be paid to how the Fed will present its future policy path at this month's Federal Open Market Committee (FOMC)." It added, "Unless the perception spreads that the inflation surge could become a persistent phenomenon due to unstable expected inflation, the likelihood of the Fed shifting its policy focus from employment to inflation is slim."
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