Since August, I have consistently maintained to my colleagues that a September rate hike by the Federal Reserve was improbable, and even if executed, its marginal scale would serve as a catalyst rather than a deterrent for the South Korean equity market. I previously articulated this conviction in a post approximately two weeks ago.
While many investors kept a vigil until 3:00 AM KST to check the FOMC announcement, I opted for a sound sleep.
[美 금리동결]증권가 “美 금리인상 시기 12월에 ‘무게’” (2015.09.18.)
[美 금리동결]늦춰진 美 금리 인상…주식시장, 단기 ‘안도 랠리’ 가능성 (2015.09.18.)
[미국 기준금리 동결] 이주열 한은총재 “단기 불확실성 여전…10월 인상 가능성 대비해야” (2015.09.18.)
Although this decision provides short-term liquidity relief, the long-term outlook remains clouded. There is merit to the adage that an early blow is preferable; instead, the market has endured weeks of agitation only to return to the status quo. Significant monetary tightening is unlikely until China achieves relative stability and U.S. labor indicators show substantive, rather than merely nominal, improvement.
While many cited improving employment data as a harbinger of a September hike, I have argued since June that these figures represent a form of statistical artifice. Nevertheless, as the underlying trend suggests gradual recovery, I anticipate the commencement of incremental hikes before March of next year.
From a technical analysis perspective, I expect the KOSPI to recover to the 2,050 level before year-end. Regarding Bank of Korea Governor Lee Ju-yeol’s recent intimations of a potential October hike, I view such statements as ‘reputational insurance’—a common tactic employed by high-ranking officials to preemptively hedge against potential errors. Unencumbered by the weight of such professional reputation―because I have none as such―I maintain my stance that no U.S. rate hike will materialize until next year.
Foreign capital began its reentry on September 17, the day prior to the announcement, while institutional investors had already begun absorbing the volume shed by foreign entities a week earlier. Due to capital constraints, I have focused my primary allocations on stable, blue-chip stocks, observing the limit-up rallies of more speculative tickers from the sidelines. Nonetheless, my active portfolio management has yielded more gains exceeding 5% than losses capped at the 2% threshold. While the absolute profits are modest, the validity of the underlying strategy remains intact.
Since several readers have inquired as to why I believe the Fed rate hike remains improbable in the current circumstance, I shall delineate my rationale below. While granular data has been omitted for the sake of brevity, the following outline focuses strictly on the theoretical conceptual framework of the prevailing constraints that structurally prevents imminent rate hike.
Federal debt, which stood at approximately $9 trillion at the end of 2007, has since expanded to over $19 trillion—representing a staggering increase of $10 trillion within a mere eight-year span. Concurrently, the Federal Reserve has injected over $2 trillion in liquidity to acquire Treasuries at elevated prices, a maneuver ostensibly designed to manage the sovereign debt-to-GDP trajectory and sustain chronic fiscal deficits.
While the term “helicopter money” is frequently invoked to describe this phenomenon, it remains a misnomer. The Federal Reserve did not dissipate its underlying capital into the real economy; rather, it executed an alchemical asset swap, exchanging newly minted liquidity for long-term duration. In essence, the Fed did not substitute capital for debt; it substituted capital with capital. This remains a “cheat code” unique to the issuer of the global reserve currency—though its long-term viability remains an open question.
⑴ The arithmetic of debt serviceability is unforgiving. With a principal of $19 trillion, even a modest 2% benchmark rate necessitates $380 billion in annual interest expenditures. Every subsequent 1.0 percentage point increase adds an additional $190 billion to this burden, while simultaneously precipitating an appreciation of the USD, thereby intensifying the real economic pressure of interest service.
⑵ Furthermore, the Federal Reserve currently holds these bonds as the primary underlying assets backing the USD. High bond prices are thus essential to mitigating the fiscal strain on the Fed’s own balance sheet. Should the Fed pivot toward a rate hike, the market value of the low-yield bonds it acquired during the easing phase would collapse. This would not only deteriorate the Fed’s mark-to-market position but also exacerbate the systemic fiscal burden.
⑶ The only viable mechanism to erode the real value of massive nominal debt issued at low fixed rates is inflation. Specifically, the Fed must maintain low real interest rates until inflation in the real economy rises sufficiently. Such an environment may facilitate a multiplier effect on fiscal health: as the USD depreciates, interest burdens are alleviated, allowing the Fed to eventually retire debt using currency of diminished real value.
Conversely, a premature rate hike would trigger a quadruple burden:
- Suppression of Inflation: Precluding the necessary dilution of nominal debt.
- Devaluation of Assets: Eroding the value of the bond portfolio held on the Fed’s balance sheet.
- Escalation of Nominal Costs: Increasing interest expenditures as market rates rise.
- Real Appreciation of the USD: Intensifying the real pressure of debt servicing.
Given these constraints, I find it improbable that the Federal Reserve will proceed with an immediate rate hike despite having commenced tapering. For the foreseeable future, the global economy remains tethered to the massive liquidity generated to remediate the great financial crisis—a condition that renders significant inflation not merely a risk, but a mathematical inevitability.