• The DXY index rose on the back of resilient US data and a hawkish Fed with a higher for longer narrative

• NEER & REER shows ringgit is undervalued

• Room for future MYR appreciation is visible

The USD index continued to remain firm on the back of hawkish FFR projections from the latest Social Economic Projections (SEPs), which foresaw fewer rate cuts in 2024, signalling that the interest rate is likely to be higher for longer. As a result, ringgit remained under pressure against the greenback, with the USD/MYR pair was last seen at 4.7220 as it broke above the key resistance at 4.7000 with a rise in the DXY but at this stage, it is premature to expect USD/MYR to rise to last year’s peak at 4.7470. We believe that ringgit would remain weak against the USD but if USD/MYR breaks below 4.6700, it would mean that it is not rising further.

The oil surge higher towards the USD100/bbl brought back memories of high energy prices in 2022, fuelling the higher-for-longer theme. Fears of renewed inflationary pressures due to the strong rebound of oil prices would force central banks to tighten further and to keep the policy rates higher for longer. Unlike 2022 however, Covid fiscal impulses have faded and major economies show signs of slowdown. US economic outperformance continues to keep the USD on the front foot. In addition, the forecasts of policy rate were raised by the Fed in its September SEPs for the next few years, giving weight to the higher-for-longer narrative that the market has been trading on. We now have to contend with more USD strength given that the US is a net oil exporter and its relative economic resilience could mean that the Fed could keep its policy rates higher and longer than other central banks, boosting the durability of the USD’s yield advantage over other currencies. However, we may see some risk of a retracement in the USD towards year end as seasonally the dollar tends to weaken at year end. There is also the risk that any signs of data releases of a likely slower quarterly growth and/or inflation pace, would also lead to a shift again towards concerns of an earlier than expected rate cut which is not priced in at the moment with most expect a cut only from around middle of 2024.

Most Asia FX fell against the USD in 3Q23 as the CNY fell to 7.30 against the USD. Chinese authorities have responded with further interest rate cuts and other policy measures to boost domestic demand, stabilize the property market, and address the local government debt risks. To rein in CNY weakness, the People’s Bank of China (PBOC) has been persistently guiding the CNY via stronger-than-expected daily fixings and has cut the foreign exchange reserve requirement ratio (RRR) to 4% from 6%. It is encouraging to see signs of stabilisation in China’s economy as the effect of the stimulus starts to kick in. The pressure on the CNY appears to be abating as well.

USDMYR traded higher for the month of September. Higher UST yields driving a widening of UST-MGS yield differentials saw USDMYR rose, despite relative stability seen in CNY. The case of rate staying higher for longer, alongside higher food and oil prices can result in a deterioration of global growth-inflation mix. This can undermine risk appetite and weigh on Asian FX, including MYR. Near term, USD strength and higher UST yields remain the biggest risks to Asian FX. Persistent rise can further undermine MYR. We still look for MYR to recover some loss ground on the back of (i) expectations of softer USD and UST yields as Fed gets closer to end of tightening cycle; (ii) China stabilisation story in 2H 2023 and that should benefit Malaysia’s inbound tourism and trade; (iii) domestic fundamentals remain largely sound.

NEER & REER shows ringgit is undervalued. For a more comprehensive evaluation, we look at effective exchange rate indices. Overall trends in the nominal effective exchange rate (NEER) and the real effective exchange rate (REER) series since 2020 have remained broadly consistent. Chart 5 shows the Bank for International Settlements (BIS) calculated ringgit NEER and REER series. When comparing the movements of the NEER and REER series with the USD/MYR, movements in the effective exchange rate indices have been relatively more muted. This indicates that some of the other currencies in the indices also depreciated against the USD over this period. More recently, YTD January 2023 to September 2023 period, the ringgit depreciated by about 6.8% against the USD, in line with the broad-based depreciation in major and regional currencies against the USD as global financial conditions continued to tighten and the global growth outlook weakened, while the NEER only depreciated by about 2.5% and REER declined 3.5%. Looking at improving growth momentum, elevated commodity prices, and increasing domestic economic activities, we believe the economic fundamentals are more in favor of stronger ringgit. This explains why ringgit has been strengthening on NEER and REER basis from June 2023 and remained stable in August and September. Unfortunately, movements in the financial market, which are more sensitive to the US FOMC’s rate decisions, caused ringgit to weaken specifically against the USD.

We see positive catalysts for the MYR to stage a rebound. Although the MYR has lost more traction in 3Q23 because of weaker development in China and higher Fed rate trajectory, there are still positive catalysts for the MYR to stage a rebound from 4Q23 onwards albeit at a more gradual pace. Positive drivers include (i) a continued recovery in China’s economy entering 2024; (ii) expectations of Fed rate cuts starting in 2Q24 that will narrow the negative interest rate gap between Malaysia and US rates as we expect status quo on Overnight Policy Rate (OPR) for the entire year of 2024; (iii) improving economic fundamentals following the execution of national blueprints of Ekonomi MADANI as well as both the National Energy Transition Roadmap (NETR) and the New Industrial Master Plan 2030 (NIMP); and (iv) sustain foreign direct investment (FDI) inflows and current account surplus, backed by a steady recovery in global demand and tourist arrivals, firmer international commodity prices and expectations of an upturn in global tech cycle beginning in 4Q23.

While the door remains open for another FFR hike, we believe the Fed is likely done with tightening for current cycle as inflation pressure is already coming off. We reckon that the hurdle for Fed to tighten again would be high if incoming data continues to show slowing inflation and further softening in labor market. Eventual dovish re-pricing can weigh on USD. On net, USD strength may still be a dominant play in the interim unless a dovish pivot comes into sight. The point of USD inflection would come when market narrative shifts into trading the expectations for “more rate cuts in 2024” and this is highly dependent on how data pans out. A more entrenched disinflation trend and more material easing of labor market tightness, activity data should bring about the shift and for the USD to trade softer.

Source: BIMB Securities Research - 4 Oct 2023