• Federal fund rate raised 25bps. The Federal Open Market Committee delivered the widely expected hike in its benchmark rate by 25 basis points (bps) to a range between 0.75-1.00%. The decision was almost unanimous with the exception of one dissention.
• Measured optimism. The Fed assessment on the US economy remained quite measured, expanding at a “moderate pace.” Fed’s economic projections were nearly unchanged.
• Reaffirms more hikes ahead. An increased number of Fed officials are expecting to raise rates at least twice more this year. The median prediction of a 3.00% funds rate by the end of 2019 remained unchanged.
• Ringgit to remain volatile in the medium term. We expect the ringgit to test the RM4.60/USD threshold in the medium term on expectations of further rate hike in June though BNM is likely to step in at the RM4.50/USD psychological barrier.
• ...but stable in the short term. In the short term, however, the USDMYR movement will likely be somewhat stable postannouncement given that the market has well over a week to price in any changes in the USDMYR pair.

Hawks prevail, as expected. FOMC’s decision to raise the Federal Fund Rate by 25bps to a range between 0.75-1.00% was in line with market expectations. It’s the third rate hike this cycle that began at its meeting in December 2015. As at Wednesday (15 March 2017), the Federal fund futures implied a 100.0% probability of a rate hike (96.0% for a 25bp hike; 4.0% for a 50bp hike). Expectations of a March rate hike had strengthened substantially since comments from Fed speakers (including the Chair, Janet Yellen) signalled improving economic outlook.

Measured optimism. The Fed assessment on the US economy remained quite measured, expanding at a “moderate pace.” Fed’s economic projections were largely unchanged. The unemployment rate for this year, 2018, and 2019

continues to be seen at 4.5%. Similarly, there was no forecast adjustment for inflation. The only adjustment made was for GDP forecast in 2018, which ticked up to 2.1% in 2018 from 2.0% previously.

Reaffirms more hikes ahead. Chairwoman Janet Yellen noted that the Fed Funds rate is below neutral rate and remains low by historical standards, adding that “we will gradually look to get to the neutral rate.” Meanwhile, an increased number of Fed officials are expecting to raise rates at least twice more this year. The median prediction of a 3.00% funds rate by the end of 2019 remained unchanged.

OUTLOOK

Committed to faster rate hike. March’s rate rise signals a faster pace of tightening relative to 2016 which saw rates rise just once (in December 2016). However, thus far, the market implied probability of a June rate hike remains a just touch better than a toss-up at just around 57.0%.

Pause in May. We believe that the Fed will likely take a breather on the interest rate lever at its next meeting in May (2nd & 3rd) as they assess the market impact of their rate hike and further evaluate the employment, inflation and consumption indicators. The probability that the Fed would hike rates in May based on the Fed Fund futures is currently at just 13.2% (see Graph 2).

February’s inflation in line. Just hours before the FOMC press conference, February’s Consumer Price Index was revealed to accelerate mildly at 2.7% (Jan: 2.5%). PCE inflation, meanwhile, stood at 1.9%, smack on Fed’s December 2016 forecast and at the upper end of the forecast range of 1.7-2.0%, However, the core PCE inflation, Fed’s preferred inflation gauge, remains stubbornly at 1.7% in January, just below the Fed target of 2.0% and at the lower bound of Fed’s 1.7%-2.0% projection for 2017. Beyond inflation, however, labour market conditions index gained 1.3 points (December: 0.6 points, revised from -0.3 points) though a crucial clue of Fed’s rate hike pace may come from the labour market performance as more workers re-enter the labour force.

Responding to Trump. While Fed Yellen insists that the rate hikes are reflective of “the appropriate evolution of policy based on trend you see in our economy right now”... rather than “a response to impending policy”, we believe that the Trump reflationary trade – and by extension, the markets – will hold significant sway on the Fed’s barometers ahead of Trump’s policy announcements.

Awaiting details on fiscal measures. We are closely monitoring details of Trump’s fiscal plan and economic agenda, which has thus far been dominated by fulfilment of some of his pre-election populist details – dismantling of the Affordable Healthcare Act and banking sector deregulation. Of particular interest would be Trump’s test of political capital in Congress given recent reports of fractures within his party on some of his fiscal plans. Assuming a modest gridlock, we expect the reflationary trade to be dialled down a notch, potentially reversing some of the Fed’s consumption and inflation barometers.

Ringgit’s resilience to be tested. The ringgit is expected to see some rocky patch from the March rate hike though we believe that its impact will be somewhat muted given that markets appear to have priced its impact fully for a little more than a week. Moving forward, the ringgit will likely be tested further on the toss up odds of a June rate hike, likely testing the RM4.60/USD level. Despite increasing certainty of a June rate hike, we believe that actual policy details, rather than ideological and sentiments, will be required for the markets to fully price in a June rate hike. Regardless, we expect BNM to commit to defending the ringgit against exchange rate volatility via open market operations, particularly if the ringgit crosses the RM4.50/USD psychological threshold. For now, our year-end target for the USDMYR remained unchanged at 4.35. Meanwhile, we expect BNM’s monetary policy to remain unchanged for the rest of the year.

Source: Kenanga Research - 16 Mar 2017