Executive Summary

As per our and the market’s expectations, the US Fed FOMC decided to keep its FFR at 5.50% - 5.75%. During the fifth meeting of the year, the Federal Open Market Committee (FOMC) maintained the Federal Funds Rate (FFR) at 5.25 – 5.50% target range, in line with what Bloomberg consensus was expecting and what the FOMC policymakers have been guiding prior to the meeting.

The Fed has lessened its focus on price stability mandate. It is important to note that the balance of the risks is now stable between “price stability” and “maximum employment”, as stated in the FOMC statement and during the Fed Chair’s press conference. We concur with this as the most recent data suggested that the US inflation is already trending down, albeit it is painfully slow and sticky to reach the 2.0% Fed’s inflation target in lieu that the headline has not dipped under the 3.0% level for the past 40 months.

The labour market has been cooling and has normalised. Beside price stability, the Fed also pursues “maximum employment”, reiterating its dual mandate. To this, the current condition only shows normalising labour market to the pre-pandemic level and provides leeway for the Fed to be patient in executing rate cut play.

We maintain one rate cut by the Fed in 2024. We reiterate that the Fed should take only one rate cut for the rest of 2024. It can happen in September or November, but we tilt more towards the former.

UST yield declines on course. We’ve seen a rally in US Treasuries (UST) in the run up to this week’s FOMC meeting as traders priced in a dovish Fed and a September rate cut. With rate cuts assumed this year and next, and with US likely, at worst, to show a soft landing, we anticipate UST yields to trek lower into next 3-4 quarters with a shift into non-inversion of the UST curve by 2Q2025.

FOMC decisions and Fed Chair hints mean more pricing in towards lower DXY. The DXY Index has been trading above the 104 level for the past week. While it was customary to see a steady trading range running up to the most important central bank in the past, post-meeting dollar reactions suggest the time is ripe for the market to price in more dollar bearish.

Does lower DXY mean a ripe time for the Ringgit to outshine? The USD/MYR is in a milestone of turning itself around to a bear trend, erasing the gains over the past few months as it hit a psychological level – a limit that we think the BNM has set – of 4.80 per dollar.

As per our and the market’s expectations, the US Fed FOMC decided to keep its FFR at 5.25% - 5.50%

During the fifth meeting of the year, the Federal Open Market Committee (FOMC) maintained the Federal Funds Rate (FFR) at the 5.25 – 5.50% target range (Exhibit 1), in line with what Bloomberg consensus was expecting and what the FOMC policymakers have been guiding prior to the meeting. Note that Fed Chair Jerome Powell reiterated a neutral stance during his testimony in front of the Senate and the House, underpinning the central bank’s approach to meeting-by-meeting decisions, but the market applauded the message conveyed.

The market cheered because, during his press conference, the Fed Chair said a rate cut in September is “on the table,” provided the inflation data continues to be encouraging, which means that this is the ‘twist’ that market participants are eagerly waiting for. We posit that his tone during the post-meeting press conference is neutral with a dovish biased tinge as he acknowledged that the labour market has “normalised”, but he also cautioned the cut will not happen if data does not permit the Fed to do so. In addition, the FOMC statement acknowledges that job gains have “moderated” and the unemployment rate has “moved up”.

The Fed has lessened its focus on price stability mandate. It is important to note that the balance of the risks is now stable between “price stability” and “maximum employment”, as stated in the FOMC statement and during the Fed Chair’s press conference. We concur with this as the most recent data suggested that the US inflation is already trending down, albeit it is painfully slow to reach the 2.0% Fed’s inflation target in lieu that the headline has not dipped under the 3.0% level for the past 40 months. However, the good news is that we saw the first decline in headline m/m changes since May 2020 (Exhibit 4), which may be the initial sign of a more meaningful downtrend in inflation itself. And if we are to strip out the necessities (energy, foods, and shelter), inflation growth is already at its slowest since March 2021.

Interestingly, while the Fed’s mandate is to pursue “low and stable inflation” by the price index for personal consumption expenditures grows annually at the rate of 2.0%, which is the set target that the central bank is pursuing currently, the messages conveyed underpins their commitment in doing so but stretching out the timeline needed. The PCE Price Index for June 2024 grew 2.5% y/y while its core grew 2.6% y/y; both are still above the Fed’s target.

The labour market has been cooling and has normalised. Apart from price stability, the Fed also pursues “maximum employment” as it carries a dual mandate. To this, the current condition only shows normalising labour market to the prepandemic level and provides leeway for the Fed to be patient in executing rate cut play. Recent data showed that the US unemployment rate rose to its highest level since 2021 at 4.1%, but the 2015 – 2019 unemployment rate average stood at 4.4% for comparisons. The non-farm payrolls, the number of job additions in the economy excluding farming-related jobs, has been slowing to the pre-Covid average of around 190k per month.

In the meantime, some forward-looking indicators suggest more pressure on the strength of the labour market. Lesser consumers are seeing more jobs available for six months ahead of expectations at a much-subdued level compared to the postpandemic level (Exhibit 7). Even in the current conditions component, more respondents are answering Jobs Hard to Get regarding employment. Thus, while current conditions may warrant the Fed to take a more measured approach, maintaining restrictive policy for too long could risk the Fed to forego its “maximum employment” mandate.

We maintain one rate cut by the Fed in 2024. We reiterate that the Fed should take only one rate cut for the rest of 2024. It can happen in September or November, but we tilt more towards the former. The Fed must cut its interest rate to avoid the risks of the US economy suddenly shifting towards a ‘hard-landing’ scenario, coupled with preventing inflation to rebound quickly. Still, with minimal quantum and thus, one rate cut seems to address those dilemmas appropriately. We may see further rate cuts in 2025, but the ever-dynamic US economic conditions postpandemic could dampen the notion, especially post-election.

Market Commentary

UST yield declines on course. We’ve seen a rally in US Treasuries (UST) in the run up to this week’s FOMC meeting as traders priced in a dovish Fed and a September rate cut. With rate cuts assumed this year and next, and with US likely, at worst, to show a soft landing, we anticipate UST yields to trek lower into next 3- 4 quarters with a shift into non-inversion of the UST curve by 2Q2025. Largely, we believe the UST market will repeat its historical tendency to lead the movement in FFR as bond players price in anticipated Fed policy changes. We note that the four Fed rate cut cycles since 1992 have shown that all had been led beforehand by UST yield declines (Exhibit 10).

Further support for UST will come from the Fed slowing its balance sheet drawdown. After the May FOMC, the Fed announced that starting 1 June 2024, it will reduce the cap on Treasury securities, allowing them to mature and not be replaced to USD25 billion per month from its previous limit of USD60 billion. This should result in a circa USD35 billion less reduction in the Fed’s balance sheet per month via the sell-down of its UST holdings. In addition, the Fed also left the cap on mortgage-backed securities (MBS), which will allow it to roll off its books at USD35 billion per month and reinvest any excess MBS principal payments into Treasuries. Fed’s holding of UST has declined to USD 4.4 trillion in July 2024 from a high of USD 5.8 trillion recorded as of June 2022.

FOMC decisions and Fed Chair hints mean more pricing towards lower DXY. The DXY Index has been trading above the 104 level for the past week. While it was customary to see steady trading range running up to the most important central bank in the world in the past, post-meeting dollar reactions suggest the time is ripe for the market to price in more dollar bearish.

Pre-FOMC meeting, the DXY was traded steadily around the 104.4 level, near the prior session’s closing price of 104.5 level, but dropped to below 104 level postmeeting. We think the downside prospect for the dollar remained bright due to the incoming rate cut signal, but what would keep the dollar supported is the ‘Trump trade’ and its safe haven allure due to the ongoing heightened geopolitical tension in the Middle East.

Does lower DXY mean a ripe time for the Ringgit to outshine? The USD/MYR is in a milestone of turning itself around to a bear trend, erasing the gains over the past few months as it hit a psychological level – a limit that we think the BNM has set – of 4.80 per dollar. What pressured the pair to trend down recently was the louder noises that called for early rate cuts by the Fed. Considering market participants already got what they wanted through the hint by the Fed that September’s rate cut is “on the table”, we think for the short term period, the ringgit is poised to strengthen further due to how undervalued it is against its healthy fundamentals.

Moreover, our in-house expectations for the OPR to stay at 3.00% throughout the rest of 2024 mean it jives well into our projections and provides another upward drive for the ringgit. Our baseline view of 3.0% inflation in 2024 means the OPR level of 3.0% is still accommodative while at the same time preventing the economy from overheating. Beyond that, we are of the view that the OPR could be raised to 3.25% sometime in late 1Q2025 or early 2Q2025, in time when we think the impact from higher wage growth and subsidy rationalisation exercises by the government to be at peak, propelled by a recovery in global trade. However, we cannot entirely discount the possibility of a rate hike happening earlier, i.e., in late 2024, if the subsidy rationalisation effects are more severe and immediate. In any case, the expected rise in OPR, whether in late 2024 or early 2025, is positive for the ringgit (based on the anticipated narrowing rate differentials vis-à-vis the US FFR).

Technically, the ringgit has risen by around 2.0% since last week. And suppose the current momentum exactly replicates itself moving forward, in that case, we may see the ringgit appreciate further past the 4.50 level per dollar within the subsequent seven sessions, benefitting from current rate expectations conditions and ringgit buying amidst suspected foreign inflow into the local bond market and OPR will remain at a 3.00% trajectory amid major central banks’ rate cuts. On the longer time horizon, we think our current 4.67 per dollar by the end of 3Q2024 and 4.63 by the end of 2024 is still appropriate given the current geopolitical uncertainties, alongside developments in the US political space. Should our view on downside risks turns out to be overstated, we may revisit our forecast later on.

Source: AmInvest Research - 1 Aug 2024