In light of inflation developments and further improvement in the labour market, the FOMC voted to accelerate the tapering process, which is now expected to end in March 2022 (previous: June 2022). This would pave way for earlier interest rate increase that could begin as early as 2Q2022. The Fed has stopped characterising inflation as ’transitory’ as inflationary pressures broaden further.

DATA HIGHLIGHTS

The FOMC Maintained the Interest Rate at 0-0.25%.

On economic outlook, the FOMC assessed that with progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen. The sectors most affected by the pandemic have improved in recent months, but continue to be affected by COVID-19. In this meeting, the Fed judged job gains have been solid in recent months, and the unemployment rate has declined substantially while supply and demand imbalances related to the pandemic and the reopening of the economy continued to contribute to elevated levels of inflation. The FOMC reiterated that the path of the economy will depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in employment as well as reduction in inflation while risks to the outlook remained, including from new variants of the virus.

In light of inflation developments and the further improvement in the labour market, the Committee decided to reduce the monthly purchase of Treasury securities by USD20bn (previous: USD10bn) and USD10bn (previous: USD5bn) for agency mortgage-backed securities each month starting January 2022. Hence, in January, the Committee will increase the holdings of Treasury securities by at least USD40bn and mortgage-backed securities by at least USD20bn a month. The Fed is prepared to adjust the pace of purchases if warranted by changes in economic outlook.

The Fed expects real GDP to recover in 2021 by +5.5% YoY (previous: 5.9% YoY) and moderate to 4.0% YoY (previous: +3.8% YoY) in 2022. On unemployment rate, the Fed’s forecast is stronger at 4.3% (previous: 4.8%) in 2021 and 3.5% (previous: 3.8%) in 2022. On inflation, the Committee has projected a stronger upward trajectory of 5.3% YoY, higher than previous estimate of 4.2%YoY in 2021, but still expect it to moderate to 2.6%, albeit higher than previous forecast of 2.2% YoY in 2022. Core inflation is also anticipated to rise further to 4.4% YoY (previous: 3.7% YoY) and ease to 2.7% YoY but still remain higher than previous forecast of 2.3% YoY in 2022. In 2021, all FOMC members expect rates to remain at this level. In 2022, all 18 FOMC members anticipate rate to increase, with majority forecasting it to increase by 75bps, implying 3 rate increases (25bps each). In 2023, all members anticipate rate to rise further, leading the median interest rate projection to increase in 2022 by 80bps and further 70bps in 2023.

All FOMC Policymakers Were in Favour of the Actions.

HLIB’s VIEW

In today’s meeting, the FOMC acknowledged that job market is expected to go back to pre-crisis unemployment rate trend of 3.5% in 2022 while inflation is expected to remain higher than 2.0% target. In line with this, all Federal officials signalled they were prepared to raise rates in 2022, with majority anticipating to raise rates three times next year to cool inflation. This is a significant shift as half of officials did not think a rate increase was warranted in the previous September meeting. As the Fed is expected to tighten monetary policy faster than Malaysia, we maintain our expectation of slight depreciation bias with average USD-MYR at 4.16 vs 4.15 average for 2021.

Source: Hong Leong Investment Bank Research - 16 Dec 2021