Oil Prices and Interest Rate Pressure Persist…Caution for Late September

Brent crude temporarily surged to $109 before slightly falling to the $105 level, and bond yields also saw a small decline. This is interpreted as a temporary pullback from an excessive rise, and market volatility is expected to remain high until the US CPI results are announced tonight and the FOMC next week.

Song Jae-kyung, CEO of Dimension Investment Advisors, stated, "Oil prices, based on Brent, touched about $109 and then came down a bit to about $105, and interest rates also slightly decreased. This provided a bit of a breather to the market, but it should be seen as a slight pullback from an overshoot. We need to see the US CPI results tonight, and until next week's FOMC, this kind of volatility is still alive. Seeing it this way might be the best way to prepare."

There is a view that the excessively low interest rate levels of the past should be seen as a process of returning to normal.

CEO Song Jae-kyung explained, "For the US, 5% is nominal, isn't it? If economic growth plus expected inflation is the basis for nominal interest rates, then the US is currently growing at roughly 2.5% in real terms, and the 10-year expected inflation is also about 2.5%. If you combine the two, it becomes 5%. So, some people say not to worry too much, that 5% is normal. They say it's a process of returning to normal from what was excessively low before."

In the past 30 years, the Fed has only raised rates once and then stopped on a single occasion, in 1997. Typically, when the Fed sets a direction for rate hikes, it has shown a pattern of multiple successive increases.

Given these past examples, it is analyzed that the Fed is likely to maintain a 'hawkish hold' scenario. This means that even if they stop raising rates immediately, they will maintain a hawkish stance, signaling that they could resume hikes at any time.

CEO Song Jae-kyung commented, "I still consider a hawkish hold as my basic scenario. But anyway, when the Fed raised interest rates over the past 30 years, there was only one time, in 1997, that they raised it once and stopped. Other than that, once they started raising, they did it multiple times, and once they set a direction, they went with it a few times."

Former President Donald Trump officially announced a pledge to pay every adult citizen $5,000 (approximately 6 million won) if he wins the midterm elections. Such large-scale cash dispersal policies are highly likely to cause inflation, similar to the COVID-19 period.

Currently, former President Trump is cornered politically due to various legal issues. As the Republican Party's chances of winning both the House and Senate diminish, he is seen as desperately proposing populist policies. This move is interpreted as a strategy to win votes from constituents ahead of the election.

CEO Song Jae-kyung said, "He officially announced that if he wins the midterm elections, he would pay every adult citizen $5,000. If this is true, it means giving adults about 6 million won each, which would naturally cause inflation, wouldn't it? If money is released like that. Trump is completely cornered."

This is interpreted as a strategy targeting the concentration of steel and aluminum plants in Michigan and Ohio, states adjacent to the Canadian border.

Michigan and Ohio are critical regions for Republican Senate majority, and Canada's tariff imposition is analyzed as an attempt to weaken the Republican political standing by harming the local economies. This is seen as a check on former President Trump's policies ahead of the election and a political maneuver for Canada's national interests.

CEO Song Jae-kyung explained, "Canada imposed retaliatory tariffs of 50%, and the key is steel and aluminum. What this means is that steel and aluminum factories are concentrated in Michigan and Ohio, which border Canada."

Although he cited tariff revenues as the funding source for this pledge, questions about its feasibility are raised due to the complex issues surrounding tariff refunds in US Supreme Court precedents.

Tariffs are taxes borne by consumers, and while there is a justification to return the revenue collected through them to the public, legal and administrative difficulties are expected in the actual execution process. Therefore, former President Trump's cash disbursement pledge is unlikely to be realized or will cause significant controversy.

CEO Song Jae-kyung said, "So, about the $5,000 cash handout you mentioned yesterday, which is a clear violation of election law by our standards, there was a question about where that $5,000 would come from, and he said it would be from tariffs."

September has historically been the worst month for the US stock market over the past 25 years, on average. The biggest reason for the stock market's weakness particularly in the latter half of September is that most US mutual funds close their books in September.

In the US, there is a 'Tax-loss harvesting' system that allows investors to reduce taxes by realizing investment losses. Mutual funds tend to sell loss-making stocks to gain tax benefits, which leads to a large sell-off in September.

While this selling pressure leads to a weak September stock market, funds withdrawn through tax-loss selling tend to re-enter the market after November, leading to a rebound in stock prices. CEO Song Jae-kyung stated, "September, on average over the past 25 years, the biggest reason for the market to fall in the latter half of September is that most US mutual funds are September-ending companies. In the US, if you incur a loss and realize it by selling at a loss, you can reduce the taxes you would otherwise pay on profits. You can get a tax deduction."

Any decision by the Fed at the upcoming FOMC meeting next week, whether to raise or hold interest rates, is expected to have a significant impact on the market. The European Central Bank (ECB) has already raised rates, and the Bank of Japan (BOJ) is also highly likely to implement further rate hikes.

If the Fed raises rates, the market will worry that a rate hike cycle is restarting. Conversely, if rates are held, the market might mistakenly believe the Fed has given up on controlling inflation, leading to a counterproductive surge in rates, CEO Song Jae-kyung warned.

CEO Song Jae-kyung said, "Next week, there is also the FOMC. The ECB has already raised rates, and the BOJ is highly likely to raise rates next week. But whatever the Fed chooses to do, if they raise rates, there will be concerns about entering a hike cycle. If they don't, the market might instead think the Fed has given up on controlling inflation, which could ironically cause rates to jump even higher."

Recent large-scale share buybacks by major domestic companies like Samsung Electronics and SK Hynix are actively supporting the market's downside. This acts as a defense against stock price declines and enhances market stability.

The KOSPI 200 Volatility Index (VKOSPI), after hitting an all-time high, has now fallen to the mid-40s, indicating that a significant portion of market leverage has been unwound. This is interpreted to mean that market overheating has calmed and volatility has decreased, like steam being released from a pressure cooker.

CEO Song Jae-kyung stated, "The fortunate thing is that compared to then, Samsung Electronics and Hynix's share buybacks are extensively underway. This firmly supports the downside. And if you look at the KOSPI 200 volatility index, VKOSPI, it peaked at over 100 then, and now it's down to the mid-40s. What that means is that a lot of market leverage has been removed."

If it breaks 5% again this time, it would be a very significant phenomenon.

This is an unusual situation where interest rates in major developed countries, not just the US, are rising together, and it can be interpreted as a warning sign for the global financial market. It suggests the possibility of a prolonged high interest rate environment and is expected to increase uncertainty in the investment market.

CEO Song Jae-kyung said, "First of all, the 10-year yield. It first exceeded 5% in October 2023 after the 2007 financial crisis, and if it exceeds 5% again this time, it will also be a very significant event."

The current market is in a 'debt party' situation with excessive money supply, coupled with inflation that began in earnest in 2022. Unlike in the past, this increase in debt is accompanied by inflation, making its severity high.

From the government's perspective, it is a very difficult structure to reduce spending. Reducing spending leads to losing public support, and instead, pledges to increase spending, like former President Trump's, are emerging. Ultimately, the government faces an unavoidable fiscal reality where it must tolerate high inflation.

CEO Song Jae-kyung explained, "Ultimately, it's a debt party. Inflation, which began in earnest in 2022, started to arrive, and now the market should be seen as having too much money released. Governments can't cut spending. If they cut spending, they lose votes everywhere, and conversely, Trump is promising to spend more. So, ultimately, there might be no choice but to tolerate high inflation."

At that time, public debt reached about 130% of GDP due to massive borrowing to finance the war.

Currently, G7 countries' public debt is re-entering the 120-130% range, facing severe debt issues similar to those immediately after World War II. This is due to the surge in public debt during the pandemic from increased government spending and economic stimulus measures.

CEO Song Jae-kyung commented, "This is the trend of public debt as a percentage of GDP in G7 countries, the so-called developed nations. When was it highest in the past? Around the end of World War II. That was the peak because, of course, to wage war, you take on a lot of debt."

Currently, these three mandatory expenditures alone exceed tax revenues, exacerbating the fiscal deficit.

The US fiscal deficit is approaching 6% of GDP and is caught in a vicious cycle where rising interest rates further increase interest expenses. This situation is causing significant tension among bond investors and could affect confidence in US Treasury bonds.

CEO Song Jae-kyung said, "In the US, social security, healthcare, plus interest expenses alone already exceed tax revenue. The fiscal deficit is approaching 6% of GDP, and it's a situation where interest is generating more interest, so bond investors are getting nervous."

The first is debt reduction through 'financial repression,' which means the government forcibly maintaining low-interest rate policies or keeping market interest rates low through methods like yield curve control (YCC). This aims to reduce the burden of debt repayment and decrease its real value.

The second method is the reduction of debt's real value through 'high inflation.' Whether intended or not, if high inflation persists, the value of currency decreases, and consequently, the real value of debt naturally diminishes. The US experienced this phenomenon of debt 'melting away' during the high inflation periods of the 1960s and 1970s.

CEO Song Jae-kyung emphasized, "In the past, how was debt reduced during this time? Firstly, debt was reduced through financial repression. Secondly, through high inflation, whether intended or not, the process of debt melting away, which happened in the 1960s and 70s, must be remembered by learning from the past." He added that current debt problems should be addressed by drawing lessons from these historical examples.

This was due to concerns that software companies would fall behind in AI technology, coupled with expectations for growth in semiconductor companies.

However, since July, this trend has completely reversed. Semiconductor stocks have fallen while software stocks have risen, coinciding with a sharp drop in memory semiconductor prices. Recently, with the Astra issue, there's a movement back to the previous long-short positions.

But CEO Song Jae-kyung advised against over-interpreting these short-term market fluctuations. The current shift in long-short positions could be part of investors' moves to realize short-term profits, and excessive expectations for specific events could lead to disappointment, he warned.

An ironic situation has arisen where, after US sanctions on Iran, control of the Strait of Hormuz and the Bab-el-Mandeb Strait has shifted to Iran.

Due to these geopolitical risks, oil prices are likely to remain high for a considerable period and should be considered a key constant in the market. Regardless of the September CPI results, upward pressure on oil prices is expected to be a major variable increasing market volatility next month.

CEO Song Jae-kyung explained, "To be honest, I don't think oil prices will come down easily now. Oh, oil prices? The current situation is that Trump isn't commenting much on the Middle East. Does anyone believe that the war will end only after the midterm elections? I don't know. But it will end, right? The current atmosphere suggests it's highly likely to last throughout Trump's term, according to some. There's no solution. Weapons are running out, and it's not going into a full-scale war. So it won't end. This is a scary thought, but they won't use nuclear weapons. They can't. So, in conclusion, it's not a situation where they can, so if you look at the stalemate, it's ironic that ever since the US provoked Iran, Iran gained control of Hormuz and Bab-el-Mandeb. So, in the current situation, it seems we have to assume that it will continue like this until Iran gets what it wants. Then, oil prices are likely to remain high for a considerable period, and we should treat that as a basic constant in the current situation. So, I don't know what today's CPI will be, but even if it's similar to forecasts, the problem is September. It's next month because of oil prices, right? That's right. If oil prices were falling, we wouldn't be this worried, but oil prices have actually gone up."

The US debt structure is such that it can only continue to increase, and it is more likely to grow than to shrink. Due to this debt problem, the US will have to bear higher real interest rates and term premiums when borrowing funds, which is a major reason for interest rates to remain high.

If the government artificially tries to lower interest rates, the dollar is likely to weaken further. Assuming that these macro variables become entrenched in a high interest rate and high inflation environment, the future market will inevitably see value and dividend stocks perform much stronger than growth stocks.

Therefore, CEO Song Jae-kyung advised investors to reconfigure their portfolios in response to these environmental changes and focus on companies that consistently generate profits and pay dividends.

While the current 5% US interest rate might seem like part of an economic normalization process, because growth was created based on debt, this normalization process could end shorter than expected and quickly shift to inflation instability. In such a situation, it is advisable to shift to value stocks rather than a portfolio centered on growth or momentum stocks.

Maintaining a portfolio focused on stocks that performed well in the first half could be risky, and in the second half, investments need to consider changed environments such as interest rates. In the domestic market, sectors with strong value stock characteristics, such as bank stocks, are performing well, suggesting that the market has already begun to reflect these changes.

CEO Song Jae-kyung emphasized the need to diversify portfolios by also considering sectors that could benefit from a weaker dollar and companies that import many overseas raw materials.