OVERVIEW

• The ringgit has been steadily appreciating to a near seven-month high vis-à-vis the US dollar on the back of improving economic fundamentals and partly over market scepticism of Federal Reserve’s sanguine outlook on the economy.
• We reckon that economic fundamentals have increasingly overtaken USD weak performance in prompting the current ringgit uptrend but its upside is still facing some resistance amid lingering external risks.
• Additional lift for the ringgit would likely be driven by the market paring down dollar strength on Washington’s mounting political woes and Federal Reserve’s challenge to retain market confidence on its rate normalisation plan.
• With the current mix of positive outlook and lingering risk, we see a stronger, albeit still volatile, ringgit. Hence, we project the USDMYR to move within a range of 4.20-4.30 in the near term or 3Q17.
• As the ringgit now seems to be less vulnerable to devaluation, and combined with a more stable economic environment, we revise our USDMYR year-end target to 4.15 from 4.35 previously.

A pivotal turnaround? The ringgit has been on a steady ascent over the past week or so and hit a seven-month high of 4.2540 early yesterday (15th June) to the US dollar in spite of US Fed rate hike and supported by signs of further improvement in the economic outlook. Compared to USDMYR’s highest point of the year, which was reached in early January at 4.4975, the ringgit gained approximately 5.5% to the greenback. A slew of good economic indicators, namely the surprisingly higher 1Q17 GDP growth (5.6% Vs. Consensus’ 4.8%) backed by domestic demand, higher exports and sustained manufacturing output, helped to provide the fundamental support.

But the USDMYR later rebounded to 4.2675 in late session as some investors may have given the Fed the benefit of the doubt of another rate hike by year end though the market generally remained sceptical. Predictably (in line with the median investors' outlook) the Fed raised its base rate and provided more guidance on their plans to deleverage the Fed's balance sheet. The moves came against a revision of short-term forecast for inflation (2017 core PCE inflationary expectations revised down to 1.7% from 1.9%) and medium-turn sustainable (or neutral) rate of unemployment (from 4.7% to 4.6%); both targets suggesting the Fed could have paused the rate increase. Instead, the Fed continued to raise interest rates, suggesting that monetary policy is currently running countercyclical to inflation as core PCE inflation remained below the target 2.0% (April: 1.5%). This means that dollar strength would likely dissipate after it gained traction in the wake of Fed’s hawkish stance.

Relative broad gains against majors. Apart from the USD, on a year-to-date (YTD) basis the ringgit has also been appreciating against many major currencies. So far, the ringgit has been steadily appreciating against USD, CNY, GBP and SGD (see Graph 1). But more importantly it has appreciated against USD and SGD currencies on a YTD basis, a reversal from an extended depreciation over the past year (12 months) or more (Graph 1). Meanwhile, the ringgit has also pared down its weakness against AUD and EUR on a YTD basis compared to the past 12 months.

Moving up the ranks. To measure how far the ringgit has fared against other major and regional currencies, we have come up with a ranking table based on each currencies relative performance against USD. Following ringgit’s better performance thus far, it is not surprising that the MYR has steadily moved up the ranks to the 5th position (Graph 2) from 9th at the beginning of the year. More importantly, the MYR has outranked SGD and AUD, which were ranked top three at the beginning of the year when the MYR was at ninth spot.

It’s all about improving fundamentals. For now, we reckon that economic fundamentals are increasingly the dominant factor boosting the value of the ringgit as opposed to a broadly weaker USD. A recent slew of positive economic data from Malaysia may have helped to boost investor confidence on the underlying fundamentals that support the ringgit. In particular, the surprisingly better-than-expected domestic demand driven GDP growth in the 1Q17 (5.6%) changed the perspective towards economic growth momentum going forward. In line with major revisions by economists on the 2017 GDP growth forecast (ranging from high 4.0% to low 5.0% vs. a low-to-mid 4.0% previously), we have also revised our GDP growth forecast to 5.2% from 4.8%.

Support from improving global trend. Improving global economy, higher commodity prices and foreign investments have given an added fillip to the economy. Better export demand for manufactures, especially electrical and electronics as well as commodities, would continue to support a positive trade balance and help stem further narrowing of the current account surplus. Meanwhile, the government is expected to achieve its fiscal deficit target of 3.0% of GDP this year on the back of higher revenue from businesses and, to a certain extent, from the oil & gas sector. As the burden of financing big infrastructure projects are increasingly delegated to the private sector – with a large portion to be derived from foreign investors, mainly from China -- it minimises the need for the government to borrow. This would allow the government to maintain its debt to GDP level of below 55.0%.

Less vulnerable to devaluation. A quick comparative study of the major economies in the emerging market shows that theoretically, countries with a combination of a positive current account surplus and relatively high external reserves cover over external debt would likely be less susceptible to currency devaluation (Chart 3). Malaysia is one of the countries that seemed to be less prone to such risk judging by its manageable current account surplus and relatively high external reserves. We reckon Malaysia’s vulnerability to devaluation would gradually be reduced given the expectation of wider current account surplus, thanks to recent better-than-expected exports data and possibly higher external reserves. The latter is partly due to the more stable ringgit following the Financial Market Committee’s (FMC) measures to curb the trading of ringgit offshore in the form of non-deliverable forwards and expand the onshore ringgit market last December. It also required exporters to convert 75% of export proceeds to MYR (with allowance for hedging foreign currency obligations).

Rising political troubles and Fed’s ambiguity to pare down USD strength expectations. An additional factor that could technically lift the ringgit value is obviously a weaker US dollar. Earlier enthusiasm for a stronger US dollar driven by US President Donald Trump and his policies appear to have fizzled out. Mounting political issues, the ongoing investigations into Russia's involvement in the US election, have pared dollar strength expectations further. Adding to the dollar weakness is the investors growing concern that that Federal Reserve Chair Janet Yellen and her team members are behind the curve in evaluating the increasingly fragile US growth momentum. This may lead to ambiguity or even error in giving forward guidance on the pace of further tightening 

Weak economic data erodes Fed’s rate hike conviction. Further diminishing expectations for aggressive action by the Fed this year is the latest weak job data and the stubbornly low core inflation rate. The jobs number turned out to be a huge miss as it fell short of consensus’ call for 185,000 new jobs creation when the actual number came in at just 138,000 in May and revised down April’s report of 211,000 jobs created all the way down to 174,000. The unemployment number dropped to a new low of 4.3%, but that was largely a factor of more people leaving the workforce. The labour participation rate fell 0.2 ppt to 62.7%, matching an all-time low. Meanwhile, the Fed's preferred measure of inflation, the core PCE inflation, is expected to remain below the target 2.0% (1.5-1.7%) this year, according to the Reuters’ recent poll. The Fed latest rate hike would bring into question its commitment both to the data and also to its 2.0% inflation target. This would entail that the probability of another planned rate hike this year may be low if inflation remains below 2.0% and jobs creation deteriorates.

Lingering risks. In spite of the steady upside trend and the relative stability, the ringgit is still facing some resistance amid lingering external and domestic risks. Weaker foreign demand, trade protectionism by the US, China’s slowing economy, growing geopolitical risk especially in the Middle East (tension with the Shia’s, led by Iran, and Sunni Muslims by the Saudis), and capital outflows pose downside risks to growth. Furthermore, a continued downtrend of crude oil prices, which would largely impact the Government’s tax revenue, coupled with ballooning operating expenditure from emoluments (salary, pension, benefits, etc) to civil servants, may jeopardise the government’s effort to rein in fiscal deficits. Along with a shrinking current account surplus, it could further exert pressure on sovereign credit ratings.

OUTLOOK

A precariously firmer ringgit in the near term. With the current mix of better growth outlook and lingering risk, we see a stronger albeit volatile ringgit. Hence, we expect USDMYR to move within a range of 4.20-4.30 in the near term or the 3Q17, a shift from our earlier target range of 4.30- 4.40. Therefore, as long as crude oil prices remained below USD50 per barrel pressured by supply issues, it would be a challenging prospect for the USDMYR to break below the 4.20 barrier. But that would change assuming the dollar resumed its downtrend. Typically, there is an inverse relationship between the value of the dollar and commodity prices. When the value of the dollar weakens against other major currencies (Chart 7), the prices of commodities generally move higher in particular crude oil prices. This, in our view, may gradually push crude oil price above USD50/barrel towards year end and would partly help to give the extra boost to the USDMYR to break below the 4.20-level.

A stronger ringgit by year end. Our bullish ringgit outlook stems from the belief that improving fundamentals are increasingly outweighing the risk of further US rate hikes or lack thereof. With economic growth for the whole of 2017 now seemed poised to break the 5.0% barrier (Kenanga forecast: 5.2% vs. 4.2% in 2016) and increasingly more stable financial flows into Malaysia on renewed global interest in bond and equity markets, we expect these factors to provide a steady momentum for a firm appreciation of the ringgit over the next 6 to 12 months. As the ringgit now seemed to be less vulnerable to devaluation and combined with a more stable economic environment we are revising our USDMYR year-end target to 4.15 from 4.35 previously.

Source: Kenanga Research - 16 Jun 2017