US Fed Likely to be Patient in Raising Policy Rate Going Forward

The US Federal Reserve (US Fed) decided to keep its federal funds rate (FFR) unchanged between 1.50-1.75% in the latest May FOMC meeting, as widely expected. On the economy, US Fed indicated that “labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Recent data suggest that growth of household spending moderated from its strong fourth-quarter pace, while business fixed investment continued to grow strongly.” As a result, we believe the US Fed may likely raise its FFR by another 25 bps to 1.75-2.0% by end 3Q18 and another 25 bps to 2.0-2.25% by end 4Q18.

Based on the US Fed dot plots analysis, as well as the earlier guidance on the Fed’s balance sheet normalisation program, we also believe the subsequent US Fed’s FFR hikes will also likely be gradual next year. Nevertheless, the US Fed highlighted that “assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments,” signalling that rising inflationary pressure could be determining the direction of FFR. US Fed noted that “both overall inflation and inflation for items other than food and energy have moved close to 2%.”

While US’s inflation is still expected to remain manageable in the near term, we believe the recent increases in energy prices may put some upward pressure, but not likely to change the monetary policy stance significantly if the Fed continued to view such factor as transitory, and not supported by strong labour market conditions. This was supported by the statement stating that “economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

In Malaysia, the stance of the country’s monetary policy will remain accommodative and supportive of domestic demand. We believe BNM will likely maintain its policy rate at 3.25% in 1H18 and wait until 2H18 to gauge the state of the Malaysian economy, before deciding on whether to raise OPR by another 25bps to 3.5% by end-2018. Supported by steady sustained economic growth, as well as expectations of higher commodity prices and possible monetary policy normalisation in 2H18, we expect Ringgit to trade between RM3.85-3.90/US$ throughout most of 1H18, where Ringgit may appreciate to RM3.80/US$ by end 2018.

Source: Affin Hwang Research - 3 May 2018