OVERVIEW

• Done deal. The FOMC expectedly voted to raise the Federal Fund Rate by 25 basis points (bps) bringing the target range to 1.25%-1.50% at its eight and final monetary policy meeting for 2017. This would be the third rate hike this year following quarter point hikes in March and June respectively.
• Fed signals more hikes. Policymakers’ median forecast was for another three quarter point increases in 2018 and two in 2019, even as they acknowledged inflation is continuing to undershoot their target.
• Change of guards creates uncertainty. The transition and changes in the Fed’s leadership will create added uncertainty over the path of the monetary policy and its impact on the US economy in the coming year.
• BNM likely to follow suit. Along with a steady growth trend and partly to cushion any adverse impact of the Fed rate hike on the capital market and the ringgit, it would not be a surprise if BNM would convert its hawkish overtones into actual decision to raise the overnight policy rate (OPR) at its first Monetary Policy Committee meeting in late January.
• A temporary downside bias for ringgit. We do not discount the possibility that the ringgit would face headwinds and may undergo some degree of depreciation pressure in the short term. While we expect the USDMYR pair to fluctuate between 4.05- 4.15, we maintain our year-end target of 4.15.

A done deal. The Federal Open Market Committee (FOMC) decided to raise the Fed Fund Rate by 25 bps to a range of 1.25-1.50%. The decision is in line with Bloomberg’s median consensus estimates, as anticipated by more than 90% of its respondents surveyed. This would be the third rate hike this year following quarter point hikes in March and June respectively.

Fed signals three rate hikes in 2018. Policymakers’ median forecast was for another three quarter point increases in 2018 and two in 2019, even as they acknowledged inflation is continuing to undershoot their target. Two policymakers – Charles Evans of Chicago Fed and Neel Kashkari of Minneapolis – dissented against the decision to tighten policy, having both previously flagged up concern about sluggish inflation.

The statement: maintains gradualist approach. In a statement accompanying its rate decision, it states that “The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labour market conditions will remain strong.”

Inflation to meet target in the medium term. The Fed predicted that although inflation will continue to run below 2.0% it should stabilise around the central bank’s target in the medium term. More importantly, the Fed upgraded its job market assessment, saying its policy is “supporting strong labour market conditions”, and further adds that “averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further.”

Fed upgrades growth forecast. The Fed now expects GDP to come in at 2.5% in 2018 (Table 1), up 40bpsfrom the previous forecast. In a press conference Fed chair Janet Yellen said that “most” of her colleagues had factored in the prospect of a fiscal stimulus into their outlook. Earlier, House/Senate conference on the tax bill has reportedly reached an agreement in principle, which would pave the way for the plan becoming law before the end of the year. Meanwhile, unemployment is expected to drop to 3.9% in 2018, a 20 bps less than seen three months ago. Core personal consumption expenditires (PCE) inflation projection for next year remains unchanged at 1.9%.

Outlook

Adieu Yellen. The departure of Janet Yellen’s as Fed chair seemed to be rather an unsettling one in her effort to resolve the US economic quandary. Despite going off with four rate hikes under her cap, the Fed is still grappling with the issue of low inflation amid robust employment growth and surging capital market depicting a bubble. While this is Yellen's last press conference as Fed chair, she will remain in charge at the central bank for 2018's first meeting scheduled late January.

Change of guards raises uncertainty. The transition and changes in the Fed’s leadership will create added uncertainty over the path of the monetary policy and its impact on the US economy in the coming years. Though it was expected that President Donald Trump nominated Jerome Powell as the next Federal Reserve Chair, he is often perceived as a merely Republican version of Yellen. While he is expected to continue a gradual tightening policy, the market thinks he may raise interest rates slightly faster than Yellen. This would create uncertainty over the pace and direction of the financial market and the USDin 2018.

BNM likely to follow suit. Along with a steady growth trend and partly to cushion any adverse impact of the Fed rate hike on the capital market and the ringgit, it would not be a surprise if the Fed decision would further reinforce BNM to convert its hawkish overtones into actual decision to raise the overnight policy rate (OPR) by 25 bps at its first Monetary Policy Committee meeting in late January. Given that the Fed had signalled three more rate hikes in 2018 there is a probability that BNM may consider raising the OPR by another 25 bps, bringing the total rate hike to 50 bps for 2018. However, this would premised on whether GDP growth would sustain above potential.

A temporary downside bias for ringgit. We do not discount the possibility that the ringgit would face headwinds and may undergo some degree of depreciation pressure in the short term. While we expect the USDMYR pair to fluctuate between 4.05- 4.15, we maintain our year-end target of 4.15.

Source: Kenanga Research - 14 Dec 2017