We maintain our global reflation story of better global trade and fiscal expansion supporting a stronger global GDP outlook which we project at 3.6% and inflation at 3.4% for 2018, added with monetary tightening policy. For now, we are playing down deflation, stagflation and productivity issues. However, despite painting a positive outlook on the global scenario, our near-term focus for 2018 and 2019 remains on salient issues such as: (1) US Fed policy; (2) trade war retaliation; (3) currency war; and (4) emerging market debt crisis.

As such, we believe the outlook of the USD and the Japanese yen, which is seen as the safe haven currency, will continue to play a dominating role in the near term. The USD is expected to gradually appreciate against other currencies in 2018 largely due to the US Fed continuing to raise interest rates much faster than other central banks, thus making USD-denominated assets more attractive in terms of yield differential. The Japanese yen will be attractive partly due to its safe haven status and potential room for gradual and small tapering of the QE. Likewise for the euro, as we expect the QE to end by December 2018 with rates moving up in 2H2019.

With the USD on a strengthening note, added with ongoing noises that will continue to cause vulnerability on financial markets, we expect the Malaysian ringgit to remain on a weaker note. Room for BNM to reprice the OPR remains low despite expectations of inflation to stay weak following the introduction of fuel subsidy and removal of the GST which is replaced by the SST. The SST covers only 38% of the CPI basket compared to the GST which impacts 60% of the CPI basket, freeing up around RM70bil for consumers to spend. Besides, wages in export-oriented industries should improve while some optimism outlined by manufacturers with evidence of higher output has allowed them to adjust their payrolls upwards, thus translating into higher spending and a positive impact on business activities in the retail segment and SMEs.

A. Recap of currencies’ performance

• DXY: The dollar exhibited a roller-coaster ride in July. The DXY performance was influenced by the flows into US Treasuries following President Trump’s administration to tax 10% on Chinese goods worth US$200bil. Besides, the USD rally was impacted by macro data, especially the firm inflation figure in June which rose by 2.9% y/y from May’s 2.8% y/y that supported the case for a fourth rate hike. However, the USD rally streak broke when the US president criticized the Fed’s monetary policy that was later downplayed by the US Treasury Secretary. In July, the DXY weakened by 0.33% m/m to close at 94.554 by the end of July.

• Euro: The euro primarily traded sideways in July. The euro received some fresh catalysts following the comments from ECB members on the likelihood of a rate hike kicking in sometime in late 2019, which drove expectations that it could happen in September or October 2019. But the gains were erased after the ECB president reiterated on the ECB’s forward guidance, reaffirming rates will remain unchanged “through summer 2019”. Meanwhile, over the course in July, tensions eased in the bloc with: (1) German Chancellor Angela Merkel securing an agreement on the migration deal; and (2) trans-Atlantic trade relationship improved with the US and the EU, both agreeing to work towards “zero tariffs”. The euro gained 0.4% m/m to close at 1.1691 against the dollar.

• JPY: The currency lost its safe haven status during the month as monetary divergence overshadowed the news on intensifying trade tension. The yen hit a YTD low of 113.09. However, it managed to pare losses after speculation rose that the Bank of Japan (BOJ) plans to tweak its monetary policy. As of the end of July, the yen fell 0.9% to close at 111.86 against the dollar.

• GBP: The pound gained at the start of the month following the release of stronger-than-expected economic data which supported the Bank of England (BoE) to call for higher rates as the weakness in 1Q2018 was viewed as temporary. But the pound was later weighed down to a year-to-date low of 1.3014, dragged by negative Brexit headlines following Merkel citing that the Brexit plan as “unworkable”. This was followed by the resignations of pro-Brexit ministers i.e. Boris Johnson and David Davis. However, the Brexit topic cooled after PM Theresa May announced that she will be leading the Brexit negotiation which raised expectations that the UK will head for a “soft” Brexit. The pound slid 0.1% m/m to 1.3124 against the greenback at end-July.

• Ringgit: The Malaysian ringgit was under pressure during the month. The currency slipped by 0.6% m/m to 4.0652 in July. Part of the drag was due to the 2.9% m/m drop of the Chinese yuan against the USD, a currency ringgit somewhat tracks closely. Weighing on the ringgit is also foreign outflows in the local bourse amounting to RM1.7bil in July to end at RM8.6bil YTD and lower reserves which fell by US$3.8bil to US$104.7bil at the end of June 2018. But the slide in ringgit was contained with better activities in local bonds with the 3-, 5-, and 10-year yields down by 6.6bps to 3.555%, 8.8bps to 3.760%, and 13.2bps to 4.068% respectively during the month. Besides, Bank Negara Malaysia (BNM) left the benchmark interest rate unchanged at 3.25%, which fell within our and market expectations supported by weaker June inflation of 0.8% y/y from 1.8% y/y in May following the removal of the GST.

B. Outlook

• We expect the USD to gradually appreciate against other currencies in 2018. We believe the US Fed will continue to raise interest rates much faster than other central banks thus making USD-denominated assets more attractive in terms of yield differential. We project two more rate hikes in 2018 i.e. September and December, each by 25 bps from the current 1.75%– 2.00%.

• At the same time, with the removal of excessive monetary liquidity from financial system, ongoing noises such as trade retaliation, fear of emerging market debt crisis that could turn contagion and political noises with the US mid-term election on November 6 will continue to cause financial markets to remain vulnerable.

• We believe the ongoing noises are expected to cut short the lack of clear-cut fundamental support for a strong USD with issues like twin deficits (budget and current account). Hence, the return of risk aversion is likely to drive the USD higher as investors make a flight for safety apart from the Japanese yen which is still defined as a safe haven currency

• Looking ahead into 2019, upwards USD momentum could still continue on the back of rising interest rate. We expect the Fed to raise rates by another two times to normalize at 2.75%–3.00%. However, should inflationary pressure become much stronger than expected, possibilities for the normalization rate to end at 3.25%–3.50% remain, implying that the rate hike in 2019 could end up three or four times each by 25bps.

• In the case of the ECB, while we expect the tapering to end by Dec 2018, we are not factoring in any change to the current policy rate until 2H2019. We believe the first rate hike could likely happen in 3Q2019 should the future incoming data beat expectation or point to stronger numbers. Hence, while we need to scrutinize the potential incoming data, at the same time we need to watch closely the tone and language from the ECB. As such, we can expect excitement on the euro at least 6 – 12 months ahead of the change in the policy.

• In the meantime, we believe the Japanese yen will be another exciting currency. Apart from being supported by its safe haven status, the potential incoming data as well as the tone and language by the BOJ will play an important role in determining the direction of the yen. Room for gradual and small tapering of the QE is now on the cards.

• We foresee the Chinese yuan to lean more on a weakening bias against the USD. The PBoC is expected to maintain the current policy rate. However, the possibilities for the central bank to further cut the reserved required ratio in a move to support domestic activities is still high. More so if the ongoing trade war with the US becomes uglier. A slowdown in the deleveraging process and allowing the yuan to weaken further are policy tools that are likely to take place.

• With the view of the strengthening USD added with ongoing noises that will continue to cause vulnerability on financial markets, we expect the Malaysian ringgit to remain on a weaker note. Furthermore, we believe there is less urgency for BNM to reprice the current OPR of 3.25% despite expectations of inflation to stay weak following the introduction of fuel subsidy and removal of the GST which is replaced by the SST. The SST covers only 38% of the CPI basket compared to the GST which impacts 60% of the CPI basket, freeing up around RM70bil for consumers to spend. Wages in export-oriented industries should improve while some optimism outlined by manufacturers with evidence of higher output has allowed them to adjust their payrolls upwards, thus translating into higher spending and positive impact on business activities in retail segment and SMEs.

Source: AmInvest Research - 7 Aug 2018