Rising Concerns of Inflationary Pressure in the US

Jerome H. Powell has been recently sworn in as the 16th Chairman of the Board of Governors of the Federal Reserve System, replacing the outgoing Janet L. Yellen. We believe the new incoming Chairman will be faced with some tough decision on the direction of US monetary policy, especially on the number of rate hikes that the US Fed will announce this year, in balancing between its dual mandate of price stability and full employment.

Higher US Inflation Numbers May Influence the Monetary Policy Stance

Some market observers believe that the January’s consumer price index (CPI), which will be released by the US Labor Department on 14 February and the producer price index (PPI) on 15 February, may be an early signal of rising inflationary trend and pressure, following the better-than-expected strength US labor market, as reflected in the nonfarm payrolls and unemployment rate in January. There are also concerns that the in the coming months US inflation numbers may also influence the monetary policy stance and wordings of the FOMC statement on 20-21 March 2018, where the US Fed may raise its Fed Fund rates by 25bps more than the guided three times in 2018.

Improvement in US Labour Market and Rising Wage Growth

The US unemployment rate (U3) improved to 4.1% (a 17-year low), and unemployment rate including discouraged and part-time workers (U6) also improved to 8.1% in December (from 17.1% in April 2010). However, despite the improvement in the unemployment rates, the US labor force participation rate remained at 62.7% for the fourth consecutive month in January (only marginally higher than a record low of 62.6% in August 2015), as compared to a peak of 67.3% in year 2000, signalling that the US labour market is still at a level considered to be manageable, which may not translate directly into higher inflationary pressure going forward.

Will Trump’s tax reform accelerate economic activity leading to inflation?

Another reason fueling inflation expectations was President Trump’s tax reform. However, we believe that as the tax reform is not a permanent tax cut, but a temporary measure lasting up to year 2025, the assumed positive impact to the US economy may not be as significant. According to Fed’s Beige Book released in January on the US tax cuts, businesses in the manufacturing sector are not expecting much investment activity from the tax reform, where it opined that the extra profit from corporate tax cut will be more likely to be used for mergers and acquisitions or for debt reduction as well as stock buybacks rather than investment activity.

Maintaining Our Forecast for Fed’s Three Rate Hikes in 2018

The US Fed is likely to continue with its gradual monetary policy normalisation process, where we expect only three rate hikes in 2018, no change from our earlier expectations. The latest traders implied probability has also trended lower to 47.1%, as compared to last week’s expectation of 65%, reflecting traders are also expecting the Fed to increase the rate by 3 times in 2018.

Future Direction of OPR Will be Data-dependent

In Malaysia, from the domestic perspective, as we believe the US Fed will be diligent in managing market expectation on the pace of subsequent rate hikes going into 2018, we believe there is no hurry for Bank Negara Malaysia (BNM) to raise its overnight policy rate (OPR) further any time soon.

Source: Affin Hwang Research - 14 Feb 2018