A major systemic risk is brewing. There is lack of sign of US debt ceiling resolution and this is a major concern. Republican and Democrats parties are at loggerhead over many issues on how to come to an agreement over budget sequestration that could be the deciding factor to increase the debt ceiling. Issues at hand range from a cut in defense and non-defense budget, from education to health care to Pentagon budget. The deadline of potential debt default is fast approaching which is about 10 days away, specifically on 31st May. In our view, both resolutions either to increase or decrease fiscal budget will cut both ways amid the former that may results in US Treasury yield to jump or the latter could cause US economic growth to suffer. Additionally, the loggerhead of budget sequestration or the resulting budget sequestration may result in a downgrade in US sovereign rating, if one could recall the 2011 budget sequestration impasse. This could push investors to rebalance their portfolio to low risk aversion region and this is where the EMEs financial market could prevail. This will be further added by Jerome Powell yet another strong statement last Friday which says that there could be a pause in US FOMC interest rate hikes in June. Note that US FOMC next policy meeting is set to take place on 13-14th June. To recap, the US FOMC further tightened the FFR by another 25 basis points on 3rd of May, pushing the FFR to 5.25%, just a tad lower than its terminal rate of 5.50%. All in all, the US Federal Reserve has normalized and tightened the FFR by 500 basis points since a year ago, unprecedented by any yardstick due to the strong inflationary pressure and sizzling labour market condition. In any case, the 25 basis points gap of the current FFR before reaching the terminal rate of 5.50% will be used as a ‘spare’ in 2H in case if inflation remains stubborn and sticky.
Aside of debt ceiling impasse, we think that investors will train their eye on US FOMC meeting minutes that will be released on 25th May (Thursday). The details of the minutes will determine risk tolerance ahead as investors remained wary over the FOMC members appetite on the direction of the FFR. Solid majority for an extended pause in FFR will push a jubilant market which could spark a much-needed rally. On the flip side, a less-than-encouraging buy-in for a pause could dampen interest, resulting in lackluster risk-taking activity. Investors will also wait in bated breath for US May unemployment and CPI numbers which are due to be released on 2nd and 13th of June respectively. We predict the numbers to drop convincingly given the aggressive interest rate hikes by the US FOMC which totaled close to 500 basis points until May. This could be harbinger for a better outlook on US CPI starting with June numbers. As the US could be skirting with recession should the FFR remains punishing, further signs of deceleration in CPI could trigger the prospect of a cut in FFR which we predict the interest to gain in traction in 3Q and 4Q respectively. Hence, our view of better EMEs equity outlook in 2H given the fair prospect of US interest rate cut, a narrative we have been propagating since early of the year. This will be added by an expected rebound in oil price, a major commodity of key EMEs particularly for Malaysia, Thailand, Indonesia, Venezuela, Brazil and hence, overall sentiment over EMEs. We predict a convincing and steady rebound in oil price in 2H to be driven by supply issue particularly with OPEC+ planned and widening supply cut. Not that OPEC+ is set to widen its supply cut by another 2mn barrel per day (bpd) starting May to 3.66 mn bpd. This will be added by the expected pullback in USD courtesy of a pause in FFR, the fast-approaching winter season in Northern Hemisphere (note: fall season in less than 3 months), protracted supply disruption due to prolonged Russia-Ukraine war and the booming again demand for air travel post COVID-19. Combination of favourable factors are expected to drive the oil price higher in line with our projection of USD90-100 bpd in 2023 (versus BNM and MoF 2023 projection of USD90 bpd. This is compared to YTD average of USD81 bpd.
Are we concern over the steady drop in Ringgit versus USD? We are not perturbed given the increasingly attractive Ringgit Real Effective Exchange Rate (REER) which remained on the downtrend and hence, Ringgit competitiveness over our major trading partners currencies. Though the Nominal Effective Exchange Rate (NEER) was on the rise after reaching RM4.48 per Dollar (12th May) against the year low of RM4.258 per Dollar (12th February), our REER has been on the opposite direction after reaching 87.62 (12th May) against 90.74 (12th February), suggesting further devaluation and hence, our trade competitiveness. We also think that it is a matter of time for Ringgit to rebound given the favourable prospects over EMEs as aforementioned and the spillover effect to Ringgit over the rise in oil price. Recall that we mentioned before that Ringgit has a negative 0.75 correlation, suggesting a 0.75 increase in Ringgit for every USD1 increase in oil price. Ringgit is expected to average between RM4.10-RM4.20 per Dollar in 2023 against YTD average of RM4.41 per Dollar. This suggests a cool 5.9% increase in Ringgit per USD compared to current price.
Sentiment for the week ahead will be driven mainly by the resolution over US debt ceiling impasse. Failure to meet the deadline by end of May could result in higher risk aversion for equity market, an overweight portfolio rebalancing towards debt instruments. The low risk asset class of debt is a winning strategy during heighten risk aversion. However, a signal of potential resolution could trigger a higher risk tolerance for equity, triggering a market rebound. Investors may also opt for a wait-and-see attitude given the still unresolved general elections in Turkey and Thailand. Unfavourable outcome, that is a change in government, could push investors to be cautious over other key EMEs elections namely Malaysia (note: state elections), Argentina, Poland and Indonesia. Sentiment may also be damped by the full blown of 1Q23 corporate earnings season. Various of overhang issues could results in lackluster trading momentum though this may change once Joe Biden is able to cut a decent debt ceiling deal with the Republicans.
Source: BIMB Securities Research - 22 May 2023
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