News

• As widely expected, the FOMC raised the fed funds rate by 25bps to 1.0-1.25% target range and laid out its plan to gradually reduce the balance sheet relatively soon.

• The FOMC said that economic activity has been rising at a moderate pace while the labour market has moderated but remained solid. The Committee noted that inflation has declined and acknowledged it will remain below 2% in the near term. However, it is expected to stabilize around the 2% objective over the medium term. Similar to last meeting, the FOMC sees balanced risk to economic outlook but added that inflation developments will be monitored.

• Economic growth projection for 2017 was slightly higher at 2.2% (previous: 2.1%); long-run: 1.8%

• Projection of unemployment was lower at 4.3% (previous: 4.5%); long run: 4.6% (previous: 4.7%).

• Forecast of both headline and core PCE deflator for 2017 was revised lower to 1.6% and 1.7% respectively (precious: 1.9%). Long-term projection for headline PCE was unchanged at 2.0%

• FOMC members’ projection of fed fund rate was unchanged at 1.4% & 2.1% for 2017 & 2018 respectively.
   
• The Committee also expects to begin the balance sheet normalization process later this year, provided the economy evolves broadly as anticipated. The cap roll -off will start at US$6bn/mth for Treasuries and it will increase by US$6bn/mth each quarter until the cap reaches US$30bn/mth. For agency and mortgage debt, the cap will start at US$4bn/mth, with quarterly increase of US$4bn until the level reaches US$20bn/mth. Once both targets are met, they total runoff will be US$50bn/mth or US$600bn/yr.

Comments

• The FOMC statement is broadly neutral. The continued improvement in economic activity and further decline in unemployment rate gave confidence to the Fed that inflation will gradually increase over time. Hence, despite the lower inflation forecast in the shorter-term, the Committee plans to press on with its gradual path of interest rate increase and balance sheet normalization.

• We opine that the Fed would likely kick start the balance sheet dial back in 4Q17 (after Sep FOMC meeting) as the process will accord flexibility of managing the yield curve while exerting lesser direct impact on interest rates. Given the recent challenges from weakening of commodity prices (i.e. downward pressure on inflation), we now opine that there will be no rate hike in 2H17.

• The kick-start of Fed balance sheet unwinding, though gradual, could be symbolic and could cause the USD to regain some strength into 2H17 after the recent weakness due to disappointment over Trump policies. Coupled with the weakening bias in crude oil prices, we maintain our view that MYR could move back to our targeted range of RM4.30-4.40/US$ in 2H17. On the local front, bond outflows may resurface in 2H17 given the series of government bond maturity from August onwards.

Source: Hong Leong Investment Bank Research - 15 Jun 2017