• US economy still churning out new jobs, shows no signs of cracks

• Will hot economy scupper the Fed’s plan to ease policy this year?

• The USD has been edging higher on the back of stronger data

• Cautious MYR trajectory as sentiment surrounding the currency remained subdued

From recession fears to overheating risk

The US dollar may have ended 2023 on a bearish note as rate cut speculation reached fever pitch, but that has certainly not set the tone for 2024. In fact, the greenback rallied in the first week of January and the year-to-date uptrend received a solid endorsement when an upside surprise in the latest jobs report diminished hopes that the Federal Reserve would begin cutting rates as early as the March meeting. The non-farm payrolls (NFP) continued to show US firms adding employment, and it came in at 353,000 in January, from a strong upwardly revised 333,000 in December. This was the best monthly job gains since January 2023 (482k) while the prior two months of job gains was revised higher by 126,000. US unemployment rate was unchanged at 3.7% but importantly, wage-driven inflation is still a concern as wage growth came in stronger at 0.6% MoM, 4.5% YoY in January. An equally stellar ISM services survey further cast doubt on the notion that policy easing is just around the corner (the ISM Services PMI jumped to 53.4 in January 2024 from 50.5 in December, the strongest growth in the services sector in four months).

Many are still holding out for a cut later in May, but even that may be too optimistic. As Chair Powell hinted at the latest FOMC press briefing and in a subsequent interview, the Fed is in no rush to lower rates when the economy is so strong. Market odds for a May cut currently stand at around 33%, leaving scope for a significant repricing if jobs growth and inflation do not cool substantially enough over the next couple of months.

Sticky inflation further diminishes hope for earlier Fed rate cut

The US dollar received a strong bullish impulse following the release of US inflation data. The Dollar Index (DXY) surged by more than 0.5% and nearly reached the 105.00 resistance level. Headline inflation came in at 0.3% MoM, 3.1% YoY in January from 0.2% MoM, 3.4% YoY in December. In comparison, core CPI inflation was stickier as it rose by 0.4% MoM, 3.9% YoY in January from 0.3% MoM, 3.9% YoY in December.

January’s hot CPI report marked the second month in a row inflation exceeded expectations and is a reminder that despite a trend decline in inflation over the past year, the battle is not yet over. Indeed, the run rate of core CPI inflation has trended upward over the past five months. Since bottoming out at 2.6% in August of last year, the threemonth annualized rate of core CPI growth has risen to 4.0% through January. Such developments are not likely to lower the FOMC’s confidence that inflation is completely under control. The “hotter-than-expected” January CPI report further weakened the expectations for earlier Fed easing. Markets are now pricing low chances of any rate cuts in March or May FOMC whilst there’s plenty of room for a further adjustment in market expectations should the inflation picture not pan out as most investors are hoping. The Fed is fairly confident that inflation is headed towards the 2% target in a sustainable manner, but there’s also likely to be some frustration that this final leg of the journey is taking longer than anticipated.

Even if the disinflation process were to speed up over the next few months, Fed officials are unlikely to throw caution to the wind as long as the labor market remains so tight. The most worrying aspect of the January payrolls report was that annual wage growth which accelerated to 4.5%, with average earnings rising by a whopping 0.6% month-on-month. Those impressive readings might not be repeated soon but they still suggest that the economy is at greater risk of running too hot than slowing down abruptly, with the softlanding narrative now looking increasingly like the base case scenario.

The case for a bullish dollar

For a while now, the USD has been edging higher on the back of stronger data. The current US inflation rate is still almost twice the target level of 2.0%. Based on this, the market concluded that the Fed is now unlikely to rush into easing monetary policy and will probably maintain high interest rates for longer than previously anticipated. At the beginning of January, according to the FedWatch Tool, the probability of a 25bps rate cut in May was around 55%. After the inflation report was released, this figure dropped to just 33% while chances of Jun rate cut are at around 52% with investors currently expecting four 25bp cuts. That is a lot closer to where the Fed’s dot plot had guided for at -75bps. With that, the room for further convergence is also a lot less and that also limits the room for further USD gains, unless there is evidence of a re-acceleration of inflation pressure in the US.

The inflation report was a boon for dollar bulls, but their joy was short-lived. The data on industrial production and retail sales were weaker than expected. In January, retail sales showed a decline of -0.8% compared to the December increase of 0.4%. As a result, the dollar was under pressure. The dollar received a slight boost as the Producer Price Index (PPI) indicated that industrial inflation in January rose just as consumer inflation did. The PPI increased 0.3% MoM, which is 0.4% higher than December’s figure. On an annual basis, the PPI rose by 2.0% (Dec: 1.7%).

This past week showcased a rollercoaster of economic revelations and market responses. Despite a mix of apprehensions, especially surrounding inflation and monetary policies, the prevailing mood remained decidedly risk-on. Expectations for a rate reduction in the first half were dampened. Yet, confidence in the underlying strength of the US economy served as a counterbalance, maintaining an optimistic outlook among investors. All this makes the case for a weaker dollar less plausible in the first half of the year, with the US dollar maintained its dominance particularly against the likes of the Euro. With economic activity in the euro area remaining subdued and showing no sign of picking up, the European Central Bank (ECB) is more likely to cut rates before the Fed does, making it difficult for the single currency to resume its late 2023 uptrend.

Of all the major currencies, the yen probably has a bigger chance of bouncing back against the US dollar should the Bank of Japan (BoJ) finally decide to end its negative interest rate policy. The BoJ has flagged April as the possible meeting to hike rates should this year’s spring wage negotiations result in large enough pay hikes.

For other currencies like the British pound and Australian dollar where rate cuts could also be delayed by their central banks, it will be difficult for them to match the strong fundamentals for the US dollar, so until the Fed makes its pivot, they look set to stay on the backfoot.

Further bolstering the greenback’s prospects in the first few months of 2024 are the heightened geopolitical threats amid the spiralling conflict in the Middle East, which is supporting demand for safe havens.

Cautious MYR trajectory as sentiment surrounding the currency remained subdued

USDMYR has risen by around 3.6% year-to-date largely on the back of a rebound in USD strength from higher UST yields and cautious comments by Fed officials. Nonetheless, we still maintain a mildly positive outlook on the MYR relative to the USD from around 2Q 2024, with support largely from external factors - eventual softer USD environment on the back of build-up of expectations from Fed cuts amid US soft landing scenario and signs of global growth recovery as we proceed into 2024. On the domestic front, we are expecting real GDP growth forecast of +4.7% in 2024, underpinned by factors such as consumer spending resilience in view of stable BNM’s monetary policy and job market. These are accompanied by tourism sector recovery and positive investment growth momentum.

2023 saw a plethora of government announcements on its initiatives. Starting with the Madani Economic Narrative as an overarching initiative, then the National Energy Transition Roadmap (NETR), New Industrial Masterplan 2030 (NIMP2030), and 12 Malaysia Plan Mid Term Review (12MP-MTR). The political uncertainty has generally dissipated and with stable political outlook, 2024 should be the year where we see implementations of medium-to-long-term blueprints, masterplans and roadmaps for economic “transition”. In this regard, watch out for developments in fiscal reforms, namely the implementation of targeted subsidy rationalisation and economic restructuring.

We expect OPR to remain at 3.00% in 2024 given our current forecasts of moderate pick up in GDP growth and inflation rate, plus US Fed on “hold-for longer” stance. Taking all that into consideration, we expect MYR to strengthen in a sustained way from 2Q 2024 onwards. We foresee the ringgit’s path to recovery this year to be bumpier but we continue to see the ringgit could end the year at 4.45.

With US rates rising, USD/MYR is also taken higher alongside regional peers. USDMYR briefly touched 4.80 level on 27 February 2024 on the back of continued USD strength & China weakness and some external balance concerns. The pair though has since come-off. USDMYR was last seen at 4.7245 as it continued to move lower. Technically, although it does suggest that USDMYR may potentially ease off but conviction is not high for now. Looking at the chart, resistance at 4.7750 with psychological level being at 4.8000 and 4.8500. Support is at 4.7110, and a break below that paves the way for testing the key psychological support line at 4.7000 and 4.6500.

A summer rate cut?

Heading towards the second half, however, the picture might start to change if the Fed does finally embark on a rate cutting cycle. The main problem with this scenario is that beyond the initial selloff, there may be limited downside for the dollar thereafter if the US economy remains comparatively more robust, preventing yield spreads with other currencies from narrowing significantly.

On the whole, however, it seems that the stars are gradually aligning for the dollar bears. The continued weakness in energy prices bodes well for a further decline in inflation over the coming months, allowing the Fed to lower rates even if there’s no downturn in sight, although this outlook is dependent on there not being a wider fallout of the Israel-Hamas war.

Barring any fresh crises or external shocks, the biggest threat to the US economy might be businesses reducing their workforce much more aggressively in 2024. With employment being one half of the Fed’s dual mandate, policymakers would not hesitate to slash borrowing costs if the labor market deteriorated.

Election and soaring deficit risks

There are other risks too that could become more prominent in the second half of the year. First is the presidential election in November, with Trump and Biden poised for a rematch. The former supports tax cuts and the latter favours more spending so neither would necessarily be negative for the markets. But Trump’s unpredictability and Biden’s age are something that could make the markets nervous if that’s the reality facing voters come November.

Finally, America’s ballooning debt poses both upside and downside risks for the dollar in 2024. Government borrowing surged in 2023 despite faster economic growth and pandemic-era spending being phased out. In mid-February 2024, the national debt stood at USD34.27tn. The level of debt has approximately doubled in just 15 years and the deficit could be even higher in 2024. Should Congress maintain the current course and debt jitters re-emerge, yields could spike higher, boosting the greenback in the short term. Alternatively, if Congress decided to rein in some of the spending, tighter fiscal policy would give the Fed more room to cut rates, adding to the dollar’s potential downfall.

All in all, a major reversal in the dollar’s fortunes appears to have been pushed back again, in line with expectations of the Fed’s first rate cut. But just as there’s little reason for the Fed to move prematurely, it’s almost certain that a pivot is coming at some point this year. The gripe here is that when that happens, the scale of the cuts will probably disappoint.

Source: BIMB Securities Research - 5 Mar 2024