Fiscal Expansion Over Interest Rate Hikes: Money Will Flow

Professor Kim Gwang-seok stated, “Even if monetary policy becomes somewhat tighter, fiscal policy will adopt more extreme expansionary measures, making it difficult to define this as an era of tightening.” He added that a liquidity-driven market can be expected until mid-October. However, the opportunities in this liquidity-driven market are expected to be greater in the U.S. stock market than in Korea.

The escalation of the Middle East war, leading to higher international oil prices and stimulating inflation concerns, was cited as the primary reason for the rise in government bond yields.

Additionally, heightened expectations of interest rate hikes by major central banks and an imbalance in supply and demand due to large-scale government bond issuance for fiscal expansion were analyzed as key factors driving up government bond yields.

In the past, when interest rates were cut, fiscal policy was also expansionary, and when interest rates were raised, fiscal policy was also contractionary, moving in the same direction. However, 2026 is projected to be an exceptional year where interest rate and fiscal policies diverge.

Increased government bond issuance inevitably leads to higher government bond yields, and the situation where both warring and non-warring countries increase fiscal injections to cover war costs and counter economic downturns is intensifying this divergent movement.

Major IBs expect an additional hike in December, followed by a freeze. Based on the Fed's dot plot, there is a high probability of one more hike with a ceiling of 4% for the policy rate in 2026, and no further hikes expected in 2027.

This projection is based on a U.S. benchmark interest rate ceiling of 4%, with no further rate hikes expected in 2027. Major investment banks (IBs) also anticipate an additional hike in December, followed by a freeze.

Comparing the 2022 inflation rate of 9.1% with this year's peak of 4.2%, inflation is clearly trending downwards. Since this is a proactive measure to counter inflation rebound from the Middle East war, further rate hikes will be difficult once the rate stabilizes.

Compared to the 2022 inflation rate of 9.1%, this year's peak has fallen to 4.2%, and core inflation has also decreased from 6.6% in 2022 to 2.9%. This is a proactive measure to address a temporary inflation rebound due to the Middle East war, and further interest rate hikes are expected to be difficult if the inflation rate stabilizes quickly.

It was emphasized that the criterion for interest rate decisions is not the absolute amount of inflation itself, but rather the year-on-year inflation rate.

Even if prices continue to rise in absolute terms, a base effect can lead to a statistical decrease in the year-on-year inflation rate. Since inflation was high in 2026, the comparative base will be higher in 2027, resulting in a lower inflation rate.

Analysis suggests that even if international oil prices remain at current levels, the year-on-year increase rate will stabilize.

Korea's 2027 budget proposal is approximately 821 trillion won, an increase of 12% from the previous year, and the country is expected to move away from deficit spending for the first time in nine years due to increased tax revenues from the semiconductor boom. Major countries such as the U.S., Japan, and China are also maintaining an expansionary fiscal stance based on the performance of their AI and semiconductor value chains.

It was suggested that without the unforeseen variable of the Iran war, interest rate hikes might not have occurred.

The rise in international oil prices due to the Middle East war resulted in a distortion of inflation rates and interest rate trends. This created a situation where monetary policy hit the brakes while fiscal policy hit the full accelerator.

In early 2026, countries showed a trend of easing towards neutral interest rates. The U.S. aimed for 3%, Korea for 2%, and the Eurozone for around 2%.

However, inflation due to the Middle East war in 2026 temporarily caused interest rate hikes, and it is expected that rates will revert to cuts after mid-2027.

Interest rate hikes are merely a brake to control speed, while liquidity supply will continue through fiscal expansion.

Record-high surplus tax revenues in countries participating in the artificial intelligence (AI) value chain are serving as the basis for fiscal injections, and demands for increased defense spending due to geopolitical instability are also driving government bond issuance and liquidity expansion.

Therefore, the liquidity effect of fiscal policy is expected to be much greater than that of monetary policy.

Increasing the debt ceiling through the OBBA Act has emerged as a key means of creating liquidity. The era of fiscal dominance has arrived, where fiscal injections drive the market, replacing the weakened influence of monetary policy.

The increase in the debt ceiling through the OBBA Act is acting as a key means of creating liquidity, and the current interest rate hikes are assessed as different from the giant step tightening phase seen in 2022.

Professor Kim Gwang-seok stated that a liquidity-driven market, centered on the U.S. market, is expected until mid-October.

In contrast, the Korean stock market may experience limited upside due to skepticism about semiconductors and profit-taking sentiment following recent sharp adjustments. The overall upward trend is expected to be steeper in the U.S. stock market.