Malaysia

Real returns to stay positive throughout 2018

February’s headline inflation moderated to 1.4% y/y while core inflation is at 1.8% y/y, beating both our and market expectation of 1.8% y/y and 1.9% y/y respectively for the headline inflation. This allows for real returns to grow wider to 1.8% in February from 0.5% in January. Apart from softer food prices which were up 3.0% y/y, the drag came from transport prices (-0.3% y/y) as well as the impact from a stronger USD/MYR and the base effect. We foresee inflation remaining soft as we move forward due to: (1) the high base effect; (2) USD/MYR is on a stronger mode and hence will ease import price pressures and transfer pricing; and (3) firm oil prices of WTI and Brent to average around US$57 per barrel and US$61 per barrel respectively. Thus, we expect the real returns to be in the positive region throughout 2018. With our baseline view for the OPR to stay at 3.25% and inflation averaging between 2.5% and 2.8%, the real returns should hover 0.4% to 0.7%. If the OPR is raised to 3.50%, the real returns would average around 0.7% to 1.0%.

• February’s inflation moderated faster than expected. Headline inflation rose 1.4% y/y from 2.7% y/y in January, falling below our and market expectation of 1.8% y/y and 1.9% y/y respectively. At the same time, core inflation, which excludes volatile items like food and energy, rose at a slower pace by 1.8% y/y from 2.2% y/y in January. This allows for the real returns to grow wider to 1.8ppts in February from 0.5ppt in January.

• Part of the reason for slower gains are due to the softer increase in food and non-alcoholic beverages, up 3.0% y/y in February from 3.8% y/y in January and dragged by the drop in transport prices of -0.3% y/y from +5.7% y/y in January. Additionally, cost of housing also declined to the lowest since March 2015 to 2.0% y/y.

• We believe inflation will stay soft as we move forward. A key reason will be the high base effect. Besides, we expect the USD/MYR to remain on a strengthening mode and hence should ease import price pressures and limit the scope of transfer pricing from producers to consumers. Also, we project oil prices to stay stable with our WTI and Brent full-year 2018 average forecast to be around US$57 per barrel and US$61 per barrel respectively.

• Assuming Bank Negara Malaysia (BNM) maintains the current 3.25% overnight policy rate (OPR) throughout 2018, and if we take into account of our full-year average CPI at 2.8% which is our base case, it translates to a positive real returns of 0.4%. If we price in our lower end of the CPI to average at 2.5%, the real returns would be around +0.7%. In the meantime, we are looking at a 30% chance for another 25bps rate hike on the OPR around September, if not December. If that happens, the positive real returns will widen on average to around 0.7% to 1.0%.

US

Hawkish tilt on ‘dot plot’

As expected, the Fed hiked the policy rate by 25bps to bring the new benchmark funds rate to a target of 1.5% to 1.75%, the sixth rate hike since the policymaking FOMC began raising rates off near-zero in December 2015. Along with the increase came the upgrades in the Fed's economic forecast, and a hint that the path of rate hikes could be more aggressive. While both the market and us have fully priced in for a three-rate hike in 2018, which is now the baseline scenario, the question is whether there will be a fourth rate hike in 2018. Our probability for a fourth rate hike of 25% is slightly lower than the markets’ expectation of 27% at the moment though the Fed funds futures market indicated a 38% chance for a fourth rate hike before the committee statement was released.

• The Fed hiked the policy rate by 25bps as widely expected by both the market and us in the recent FOMC meeting. This brings the new benchmark funds rate to a target of 1.5% to 1.75%. It was the sixth rate hike since the policymaking FOMC began raising rates off near-zero in December 2015.

• Along with the increase came the upgrades in the Fed's economic forecast, and a hint that the path of rate hikes could be more aggressive. The Fed raised its forecast for 2018 GDP growth from 2.5% to 2.7% and increased the 2019 expectation from 2.1% to 2.4%. It expects growth to cool after, with the 2020 forecast holding at 2% and the longer-run growth at 1.8%.

• Inflation expectations for 2018 remained just 1.9% for both core and headline inflation. For 2019, the forecast for core personal consumption expenditures edged higher to 2.1% from 2%, while headline stayed at 2%. The committee nudged the 2020 level up from 2% to 2.1% for both core and headline.

• The Fed officials now see unemployment running even lower than before. Currently at 4.1%, they see the rate for 2018 at 3.8%, down from the 3.9% December forecast, and 2019 to 3.6% from the original 3.9% outlook. The 2020 outlook is lowered to 4% to 3.6%.

• While both the market and us have fully priced in for a three-rate hike in 2018, which is now the baseline scenario, the question is whether there will be a fourth rate hike in 2018. Interestingly, our probability for a fourth rate hike of 25% is slightly lower than the markets’ expectation of 27% at the moment. The fed funds futures market indicated a 38% chance for a fourth rate hike just before the committee statement was released.

• Looking at the so-called dot plot which indicates individual members' rate expectations, it took a hawkish tilt. While a threehike policy remains our baseline for 2018, which means the Fed fund should end at 2.00% - 2.25%, and assuming BNM maintains the policy rate at 3.25%, we expect the gap to narrow to the region of 1.00% to 1.25% from the current 1.50% to 1.75%.

Source: AmInvest Research - 22 Mar 2018