The US Fed pointed out that the central bank was “carefully watching developments” in the economy and would “act as appropriate”, but stopped short of promising any specific interest-rate easing steps. The Fed is trying to assess “this complex, turbulent picture” that has emerged in August, with financial markets volatile as President Trump’s trade war with China escalates and the global economy weakens as a result.

It appears that the Fed chairman is trying to maintain flexibility to respond to developments at the Fed’s next policy meeting in mid-September. Looking at the Fed chairman’s speech, it seems to be leaning more towards an easing bias. We maintain our 25bps rate cut in September. However, a big challenge to the Fed is to factor in the ongoing global trade uncertainty into its framework.

With the renewed trade tension between US and China, and if it continues to worsen as what is happening now, the possibility for a 50bps cut could become higher or a series of rate cuts in 2019 could take place. For a 50bps cut in September, our probability has dropped to 20% from 40% previously after taking into account of the more hawkish views from regional Fed bank presidents.

Underpinned by external noises and increasing central banks around the world cutting rates, we are looking at a 25bps rate cut by BNM in September. We believe BNM will want to be in line with the monetary policy actions by the global central banks then to be staying “behind the curve” in a move to support potential growth given that businesses are increasingly facing cash flow issues owing to poor orders. Besides, anecdotal evidence suggests that job market is gradually getting tougher and firms are looking at flexible working hours and VSS.

Rate cut is also seen as a way to keep the ringgit competitive against the dollar. Room for the ringgit to cross the 4.20 level against the dollar in the near term remains. In our view, the slide of the ringgit passing the 4.20 level will be gradual.

Our focus will be on the yuan fixing which is expected to weaken further against the dollar. Weakness in the yuan will put the brakes on other currencies in the region, including the Indian rupee, Singapore dollar, Korean won, Malaysian ringgit and Indonesian rupiah from sliding against the dollar.

However, the Korean won will be the biggest loser due to its strong dependence on China and the US where South Korea is closely interlinked in the supply chains between these two countries. Also, the won is being hit by the dispute with Japan, which has spilled into trade between the two Asian neighbours. The most resilient currency in Asia will be the Thai baht. Despite attempts by Thailand’s central bank to weaken it by slashing the policy rate, the baht is being supported by the country’s large trade surplus, low inflation and steady growth.

In the case of ringgit, in our worst-case scenario, the ringgit could fall by 8%–10% against the dollar should the yuan fall by 10% against the dollar. The base case suggests a more range bound scenario between 4.15–4.20 against the dollar. Our best case suggests the ringgit could reach 4.05–4.10 provided there is a trade deal between the US and China that will see the yuan appreciating.

In the meantime, as highlighted in our report on 20 August 2019 titled Cocktail of factors to buoy dollar, the current rate cut is increasingly focusing on weakening currencies in an environment of low inflation and an already cheap monetary policy used to support growth. The current move of rate cuts comes with a danger — it could tip off a monetary policy race to the bottom. Thus it will raise the risk of a currency war.

A currency war will do little to boost global growth prospects. It will also be tough for the dollar to weaken due to its dominant presence in global financial markets. What could happen is that governments which are better prepared this time around with healthy foreign exchange reserves will defend their respective currencies or alternatively curb speculative activity in both onshore and offshore markets through tightening of capital controls.

Source: AmInvest Research - 26 Aug 2019