OVERVIEW

• An expected hike. The Federal Open Market Committee (FOMC) decided to raise the Fed Funds rate by another 25 basis points, with a new target range of 1.5%-1.75%. Powell retains gradual rate hike stance signalling continuity.
• More upbeat Economic outlook. The FOMC sees strengthening in economic outlook pointing to stronger growth, lower unemployment, modestly stronger inflation and higher Fed Fund rate trajectory.
• Status quo on 2018 rate hike trajectory. Based on projections and the “dot plots” update, two more rate hikes likely.
• Room for another OPR hike seen as a diminishing prospect, ringgit faces weakening bias. Though we maintain our view that there is still room for another rate hike it is increasingly limited as growth trajectory is expected to moderate going forward. Meanwhile, we expect the ringgit to remain volatile and susceptible to short term weakness.

An expected hike. As expected, the FOMC raised the Fed Funds rate by another 25 basis points, with a new target range of 1.5%-1.75%. While it’s the first rate hike of the three signalled for the year, it's the fourth increase to the benchmark overnight rate in the last twelve months, and the first rate hike by the Fed under new Chairman Jay Powell after taking over from Janet Yellen. Powell maintains gradual rate hike stance signalling continuity of previous administration. As in the previous meeting, the votes to raise rates were unanimous.

Economic projections looking more upbeat. The FOMC said in a statement that “the economic outlook has strengthened in recent months,” pointing to stronger growth, lower unemployment, modestly stronger inflation, and thus a higher Fed Funds rate. GDP this year is now seen growing 2.7% vs 2.5% previously. In 2019, growth of 2.4% is expected vs. 2.1% previously while 2020 remains at 2.0%. The unemployment rate is now seen falling all the way to 3.6% in 2019 vs. 3.9% previously. It's seen remaining at 3.6% in 2020 vs. previous expectations for a bounce back to 4.0%. Core inflation is still anticipated at 1.9% this year. For 2019 and 2020, it's seen at 2.1% vs. 2.0% previously.

Projection and dot plots points to two hikes for 2018. The Federal Reserve Board maintained December's Fed Funds projection at 2.1% for this year, suggesting two more hikes. However, 2019 and 2020 are looking more hawkish though, with Fed Funds expected to end 2019 at 2.9% (vs. 2.7% previously) and 2020 at 3.4% vs. 3.1% previously. Checking on the “dot plot” updates, it remained centered on another two more hikes by year-end, although the distribution shows officials openly flirting with the possibility of a fourth hike. the updated economic projections, the "dots" continue to point to just two more rate hikes this year, but a speedier pace of tightening in 2019-20 than previously.

OUTLOOK

Fed playing it safe. While in the last few years, the bond market has been conditioned to think that the Fed would raise rates fewer times than the Fed’s own projection (dot plot). That has changed recently as early this year when the bond market (big selloff resulting a sharp rise in the benchmark 10-year yields) began to think the Fed may raise rates more than the official projection. While the Fed did not officially change its number of 2018 rate hike projections at this meeting, the issue probably will be revisited, data permitting. Keep in mind that the Fed did tighten four times last year: three rate hikes and a balance sheet normalization announcement at the September FOMC meeting last year. One could argue that the unwinding of the Fed’s balance sheet, to some extent, is akin to a rate hike in this still-unusual monetary policy backdrop.

Another OPR hike a possibility but a diminishing prospect. In the home front, although we maintain our view that there is still room for BNM to raise the overnight policy rate (OPR) the chances of doing so is increasingly limited. This is primarily because, as the economy moves further into 2018, the likelihood for BNM to raise interest rates theoretically diminishes as economic growth is projected to moderate or fall below its potential growth trend. Furthermore, raising interest rates ahead of the upcoming 14th General Election (likely to be held by early to mid May) may be construed as an unpopular move. Therefore, a rate hike after the GE14, is a better bet.

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 3.90-4.00, we maintain our year-end target of 3.90.

Source: Kenanga Research - 22 Mar 2018