Possibility of Renewed Interest Rate Hike Cycle Increases

Director Song Jae-kyung predicted that the Federal Reserve (the Fed) is likely to implement additional interest rate hikes. He stated, “It's a timid statement, but I think the Fed will proceed with a hike. Whether long-term interest rates stabilize due to that hike will determine if we've hit bottom or not.” Thus, the Fed's monetary policy direction is expected to be a crucial factor in determining the market's trajectory, and he analyzed that a period where the sentiment of bond investors, rather than stock investors, becomes more important will arrive.

Director Song Jae-kyung explained, “The word 'cycle' means it doesn't end with a single instance. Based on past experience, once the Fed decides on a hike or a cut, it proceeds multiple times, enough to be called a cycle.” In fact, five out of the last six interest rate hike cycles led to consecutive increases. This historical pattern is the main reason why the market feels uncertain whether the current rate adjustment will be a one-off or the beginning of a long-term hiking cycle.

While some argue, citing the 1997 case when the Fed stopped raising interest rates, that the current situation is comparable, there were very unique circumstances at that time. Just three months after the Fed's interest rate hike in March 1997, the Asian financial crisis, originating in Thailand, occurred. Director Song Jae-kyung explained the situation then, saying, “Three months later, the Thai crisis began. Because of that, oil prices plummeted. Asia wasn't functioning, so there was no demand for crude oil, meaning nobody bought it.” As the Asian economy stagnated, crude oil demand drastically fell, causing oil prices to crash, compounded by Russia's moratorium crisis. To make matters worse, Long-Term Capital Management, a major U.S. hedge fund, faced bankruptcy, forcing the Fed to implement emergency interest rate cuts. Thus, 1997 was a case where complex global economic crises, not just simple interest rate policy decisions, were the backdrop, making a simple comparison to the current situation difficult.

Director Song Jae-kyung stated that he has completely shifted his perspective from anticipating a hawkish pause to advocating for interest rate hikes. He said, “I was originally leaning towards a hawkish pause, but after reviewing things on Friday, I've completely shifted to the hike side,” implying his judgment changed after checking recent indicators. Currently, the 2-year bond yield exceeds 4.6% in the bond market, indicating strong market bets on further hikes. According to interest rate futures market data, the probability of four rate hikes by June next year exceeds 50%, suggesting the market has already largely priced in the possibility of additional hikes.

Director Song Jae-kyung emphasized, “The Summary of Economic Projections is released in March, June, September, and December. The dot plot is important, but how they view future GDP growth, unemployment rate, and core inflation rate will be crucial.” Beyond the dot plot, economic indicators such as GDP growth, unemployment rate, and core inflation rate projected by Fed members will show the Fed's consensus on the direction of interest rates. Additionally, the tone of the Fed Chair's remarks and how well market expectations align will also be important variables.

Director Song Jae-kyung stated, “If they raise rates and then say, 'Oh, is this enough? The first step isn't satisfying. We need to raise more.' If they come out with that kind of attitude, the market will crash,” emphasizing the impact of the Fed's posture on the market. Market concerns are growing about how the Fed's decisions will affect long-term interest rates, and investors are closely watching the Fed's actions.

Director Song Jae-kyung pointed out, “This situation is actually happening because of the fiscal deficit, and the fiscal deficit cannot be resolved by anything the Fed does.” This implies that the fiscal deficit is difficult to solve through the Fed's monetary policy alone. The fiscal deficit is a structural problem that needs to be addressed through congressional spending cuts, tax increases, or economic growth, making it difficult to find a fundamental solution solely through the Fed's interest rate hikes. This suggests that the upward pressure on long-term interest rates cannot be alleviated merely by controlling inflation.

Unlike in the past, current AI investment heavily relies on borrowing, showing extreme sensitivity to interest rate changes. Director Song Jae-kyung explained, “AI is also being invested in with borrowed money now. Since investments are made by incurring debt, if interest rates rise, the cost of funding and the interest to be repaid will increase significantly.” This means that if interest rates rise, AI companies' funding costs will increase, directly burdening their profitability. As a result, the AI industry is likely to face greater profit pressure depending on economic conditions, indicating a significant change in its sensitivity to the economy compared to the past.

China is pursuing a new strategy to counter the U.S.-centric AI monopoly. Director Song Jae-kyung explained, “China countered by saying, 'We will open all our open-weight models, so all other countries, come here. Let's grow together with our AI using our almost free open models.'” China has offered to provide open-weight models to BRICS nations for free, aiming to curb U.S. influence in the global AI market through technology sharing. This is a strong counter-strategy against U.S.-centric AI imperialism, providing new options for other countries and expected to bring significant changes to the AI ecosystem.

Negative public opinion regarding the construction of artificial intelligence (AI) data centers is spreading across party lines within the United States. According to surveys by Gallup and MBC, when Americans were asked if they approved of AI data centers being built in their neighborhoods, opposition overwhelmingly outweighed approval by a 7-to-3 margin. Director Song Jae-kyung stated, “When Americans were asked if they approved of AI data centers being built in their neighborhoods, 7 out of 10 opposed it unequivocally. This is bipartisan.” The main reasons for this opposition are noise issues and environmental concerns due to the massive power consumption of data centers. With midterm elections approaching, the construction of local data centers is emerging as a significant political issue, which could pose a new obstacle to the expansion of the AI industry.

Director Song Jae-kyung advised, “We can't aggressively say we're investing in this situation for at least a month or two. During that period, we have no choice but to adopt a low-profile mode, so investors need to be prepared for the possibility that the stock market's price movements may be uninteresting.” This analysis suggests that aggressive investment is difficult in the short term due to the current political environment and upcoming presidential election issues. Investors should be prepared for potentially sluggish stock price movements and approach investments cautiously for the time being.

Geopolitical risks in the Middle East are escalating, raising concerns about blockades of the Red Sea and the Strait of Hormuz. Due to the possibility of such blockades, ships are opting for routes around the Cape of Good Hope in Africa, extending transit times from the original 18-20 days to nearly 50 days—more than double. Director Song Jae-kyung stated, “With the Strait of Hormuz and the Red Sea now blocked, shipping that used to take 18-20 days to Asia now takes almost 50 days going around Africa. Freight costs are skyrocketing, and tanker shipping ETFs investing in this have risen 8-fold since the beginning of the year.” This has intensified the shortage of oil tankers, causing freight costs to surge. Related markets have greatly benefited, with tanker shipping ETFs rising 8-fold since the start of the year.

Japan's Government Pension Investment Fund (GPIF) is showing signs of selling off overseas assets and returning them to the domestic market, emerging as a major supply and demand variable in international financial markets. Director Song Jae-kyung analyzed, “Japan's national pension, like the GPIF, seems poised to sell U.S. overseas assets and bring them back home. Norway's sovereign wealth fund is also selling U.S. Treasuries, and if a repatriation trend for the yen appears, U.S. long-term interest rates could remain high for a considerable period.” This suggests the possibility of the GPIF adjusting its holdings of overseas bonds and stocks, aligned with Japan's policy to induce a stronger yen. If this yen repatriation trend accelerates, it could lead to capital outflows from the U.S. market, acting as a factor pushing U.S. long-term interest rates higher.

The current market is highly unpredictable due to a complex array of variables including interest rates, oil prices, and wars. Director Song Jae-kyung advised, “In situations like these, being honest means admitting I don't know much. It would be great if interest rate hikes concluded as the market expects, but it might not. Rather than simply leaving the market, a diversified portfolio that balances across various phases will allow you to sleep well at night.” In this era of uncertainty, it's crucial to diversify risk through a defensive portfolio rather than making premature predictions. He emphasized that a strategy of balancing across various phases through diverse asset allocation, rather than simply exiting the market, will enable stable investment.