"Psychological Deterioration Seen During Past Rapid Rate Hikes... Possibility of Recurrence"
Shinhan Investment Corp. pointed out on the 14th that the recent sharp rise in U.S. Treasury yields is raising concerns about shocks to the financial and real economies.
Researchers Ha Geon-hyeong, Kim Chan-hee, and Lee Jin-gyeong stated, "Amid a favorable U.S. economic trend, U.S. Treasury yields have surged sharply due to caution over Trump’s policies," adding, "The 2-year and 10-year U.S. Treasury yields have risen by 70 basis points (bp) and 90 bp, respectively, to around 4.4% and 4.8%, compared to early October 2024."
When interest rates rise, the present value of future returns from assets such as stocks, bonds, and real estate decreases. This can lead to asset price adjustments and worsen the financial environment. From the real economy perspective, it raises the cost of financing for economic agents, suppresses credit creation, and causes psychological contraction. This can act as downward pressure on the economy.
The three researchers noted, "In past periods of rapid interest rate increases, the financial environment deteriorated and psychological conditions worsened, damaging economic momentum, so there are concerns that this could recur this time as well."
For example, during the rapid interest rate increase period from 2022 to 2023, not only did the financial environment contract, but economic momentum was also damaged due to worsening sentiment.
The researchers explained, "In this recent interest rate rise, the term premium (supply-demand factors) outweighed the short-term interest rate expectation path (fundamentals)," adding, "This is a result of increased uncertainty about the monetary policy path amid concerns over increased Treasury issuance and growth exceeding expectations, while the interest rate rise due to inflation concerns was minimal."
The short-term interest rate expectation path reflects investors’ expectations for short-term interest rates, incorporating outlooks on the economy, inflation expectations, and monetary policy fundamentals. The term premium relates to Treasury supply-demand conditions, including liquidity risk and inflation risk, which cannot be explained by fundamentals.
They further analyzed, "With improvements in supply-demand conditions, the upward trend in market interest rates is expected to pause around mid-January," noting, "The debt ceiling will be reached by mid-January, limiting new Treasury issuance and easing the burden of Treasury supply."
They added, "The overheated growth trend is also expected to converge to the average," explaining, "Survey indicators suggest strong demand inflows, but long-term business conditions remain weak, so the Federal Reserve’s adjustment of the pace of rate cuts and the end of the year-end shopping season demand inflow are expected to weaken the economic recovery."
They concluded that if the pace of market interest rate increases slows down thereafter, concerns over a bond tantrum are also expected to diminish.
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