US Economy's Appropriate Interest Rate Forecasted at 5.1%… Will Stocks Endure?

A forecast suggests that interest rates will be difficult to lower quickly due to persistent concerns about fiscal policy and inflation. Even if stock prices fall, these fundamental factors will act as constraints on interest rate reductions. Some opinions suggest that for stock investors, it would be better for interest rates to rise quickly to resolve uncertainty.

Recent aerial skirmishes have caused oil prices to soar to over $90, leading the US 10-year Treasury yield to surpass 4.8%. This situation could exert additional upward pressure on interest rates in the market.

An analysis using the Taylor Rule indicates that the appropriate interest rate for the US economy's strength is 5.1% based on the third quarter. This is higher than current market rates. An interest rate level of 5% is considered a critical threshold requiring a review of corporate profits, which could significantly impact corporate earnings forecasts.

The US Treasury is making various efforts to curb rising interest rates, including cooperation with the Japanese yen and purchasing long-term bonds. However, the bond market tends to move more according to economic formulas than such interventions. Analysis suggests that unless the appropriate interest rate of 5.1% clearly declines, Treasury intervention, while preventing sharp rate increases, will struggle to reverse the trend to a decline.

Analysis of past cases shows that during the initial one to two interest rate hikes, stock prices recorded slight negatives, reflecting the burden of rate increases. However, once rates began to rise three or more times, despite fluctuations in amplitude, the market gradually absorbed the rate hikes, and stock prices showed an upward trend thereafter.

Looking at the rate hike periods in the mid-2000s and mid-2010s, the market reacted nervously and fluctuated initially. However, as time passed and expectations for economic recovery were reflected, the market gradually absorbed the rate hikes, and stock prices showed an upward trend. This suggests that rate hikes themselves do not necessarily mean a decline in stock prices, and the market's absorption process is crucial.

In the mid-2000s, the Korean stock market showed robust performance with a boom in traditional industries such as shipbuilding, automobiles, and chemicals. During this period, the Korean stock market sometimes outperformed the US market. In the mid-2010s, the US stock market performed best, and the Korean market also maintained a high ranking, showing relatively favorable performance even during US interest rate hike periods.

It was suggested that the pervasive uncertainty in the current market poses a greater burden than the negative impact of interest rate hikes themselves. If uncertainty about rate hikes persists until the end of the year, it could hinder the market's absorption process. Therefore, it is argued that raising rates in September to resolve uncertainty would be better.

The interest rate hike period of 2022 and 2023 left a significant trauma on the market. At that time, the Fed, judging post-pandemic inflation as temporary, maintained a cautious stance on rate hikes but ultimately implemented sharp increases like giant and big steps. These unannounced, abrupt rate changes caused a significant market decline, with the Korean stock market experiencing an even larger drop than the global average. The market tends to dislike abrupt, unannounced changes in the rate path more than the rate hike itself.

From the bond market's perspective, sharp interest rate hikes are also a burden as they amplify concerns about price drops. The logic is that by raising rates quickly at the initial stage to control the magnitude of the increase, one can avoid a situation where a much larger increase must be implemented later, akin to 'not letting a small problem become a big one'.

It was pointed out that it is realistically almost impossible for the US to reduce debt risk through fiscal soundness. As seen in the past Greek case, resolving debt through fiscal soundness is a very long process. Therefore, there is a limit where interest rate hikes alone are insufficient to curb rising Treasury yields and debt burdens.

Historically, the US has actively utilized institutional changes, in addition to interest rate policy, to respond to economic crises. While there was ex-post criticism of former Fed Chairman Greenspan's low-interest rate policy during the 2000s housing market boom and the 2008 financial crisis, analysis suggests that the core of housing market changes was not merely interest rates but also institutional changes related to taxation.

The 1997 US tax law reform significantly impacted the housing market. Previously, capital gains tax exemptions were granted only once to retirees aged 55 or older, but after 1997, it was changed to allow exemptions every two years. This reduced housing transaction costs and led to housing being perceived as an investment, contributing to the revitalization of the real estate market.

When the Liquidity Coverage Ratio (LCR) was recalculated in 2014, banks were required to hold a certain amount of funds to prepare for asset value fluctuations. At that time, stocks were recognized at only 50%, while Treasury bonds were recognized at 100%. This regulatory change created a structure where banks purchased Treasury bonds for book-keeping purposes, generating unintended demand in the bond market.

It is expected that the US will likely seek to transfer debt risk through institutional changes in the form of complex legal provisions rather than choosing the path of fiscal soundness in the future. In a situation where it is difficult to secure demand for Treasury bonds due to reduced foreign purchases, the US is expected to utilize institutional mechanisms to disperse risk. However, it is also pointed out that such institutional changes alone cannot fundamentally resolve all situations.

It was suggested that raising interest rates quickly at this point, while perhaps burdensome and painful now, would lead to much better results looking ahead to next year. Market participants emphasized that they should view the current market while recognizing the probability of a September rate hike, analyzing that resolving uncertainty will contribute to long-term market stability.