US

Will Fed hike rates in June?

The market is pricing in an 82% chance of a 25bps rate hike in the June FOMC from the current 1.50% – 1.75%. This is lower than our view of a 90% chance which points to near certain rate hike, supported by strong labour data in May, room for inflation to modestly overshoot the Fed’s 2% target and healthy GDP growth, underpinned by tax cuts and federal spending which will compensate any shortfall from exports.

We are not expecting any major adverse impact from the Fed decision to raise rates in June since it has been communicating well on potential rate hikes and shrinking the balance sheet to avoid the 2013 taper tantrum which surprised investors when the Fed suggested it might slow bond purchases

A delay in policy tightening by the Fed will carry costs on emerging markets. Should the Fed compromise by allowing inflation to overshoot its 2% target, the risk for the Fed to act aggressively in the future becomes more glaring. It will not augur well for the emerging markets which will struggle with higher Fed rate hikes and a stronger USD. Emerging market countries on our watch list are India, Indonesia, Turkey, Argentina and Brazil.

• The much-awaited Federal Open Market Committee (FOMC) meeting, scheduled on 12 and 13 June, is a crucial one. It will determine if the borrowing cost will increase or otherwise, a decision that will impact both the consumers and investors.

• Current market sentiments indicate an 82% chance off the Fed raising rates by 25bps from the current 1.50% – 1.75% during the June FOMC meeting. It is lower than our view of a 90% chance which points to near certain for a rate hike in June. If the June rate hike materialises, it will be the second hike in 2018 after the first in March.

• The Fed’s task is to achieve stable prices and full employment. At 3.8% unemployment rate in May, it reflects the tightness of the labour market. The possibility of inflation modestly overshooting the 2% Fed’s target is in the cards. We also expect the economy to perform well in 2018 with our GDP outlook at 2.8%. Even if exports soften due to trade fights and a stronger dollar, the US$1.5tril in fiscal stimulus and a US$300bil increase in federal spending will support domestic demand with a strong tailwind. Also, we feel the current benchmark lending rate is still low to support growth.

• Meanwhile, we are not expecting any major adverse impact from the Fed decision to raise rates in June. The Fed has been communicating well on potential rate hikes and shrinking the balance sheet. It intends to avoid the repeat of 2013 taper tantrum when the Fed surprised investors by suggesting it might slow bond purchases.

• We feel a delay in policy tightening will carry costs on emerging markets. Should the Fed compromise by allowing inflation to overshoot its 2% target, the potential risk will be that the Fed needs to act more aggressively.

• Thus, we feel the Fed is will not be sympathetic on emerging markets. Hence the possibility is higher for the emerging markets to struggle with higher US interest rates and a stronger USD. As a result of this, we found the central banks like those in India and Indonesia raising interest rates by 25bps to 6.25% and 50bps to 4.75% respectively. We remain wary on Turkey, Argentina and Brazil.

Source: AmInvest Research - 8 Jun 2018