OVERVIEW

● As expected, the Federal Reserve has raised its key short-term rate by a modest 25 basis points to a still-low range of 1.75% to 2.00% for the second time this year following the one in March. It was the Fed's seventh rate increase of the current credit tightening cycle since 2015.

● The Fed now foresees four rate hikes this year, up from the three it had previously forecasted. According to the Federal Open Market Committee (FOMC), the move reflects the economy's resilience, the job market's strength and inflation that's finally nearing the Fed's target level. “The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee’s symmetric 2.0% objective over the medium term,” the Fed said, adding that risks to the outlook were roughly balanced.

● Continued strengthening of the economy prompted the Fed to signal an additional rate increase for 2018. Quarterly economic projections released at the meeting showed Fed officials’ expectations for the economy to grow at a 2.8% rate this year, up from a 2.7% forecast in March. It also predicts the unemployment rate to dip to 3.6% by year’s end, down from a forecast of 3.8% in March. Unemployment rate reached 3.8% in May, its lowest since 1969.

● Dot-plot-wise, the FOMC members’ projections for the midpoint of Fed Fund rate, the expectation of an additional rate hike is the result of a single vote shifting toward more hikes among the officials to 7-Versus-6 from 6-Vs-6 in March.

● Slippery slope. While many economists think the current growth expansion will exceed the 1990's streak, some worry about what might occur once the impact of the tax cuts begin to fade and the Fed's gradual rate hikes begin to curb growth. The Fed's pace of rate hikes for the rest of the year could end up reflecting a tug of war between a sturdy economy and the risks to growth, including from a potential trade war that could break out between the US and key trading partners namely China, the EU, Canada and Mexico. A global trade war would risk cutting into US economic growth by depressing American export sales and raising inflation.

● On the home front, the biggest risk to the monetary policy outlook is that a post-election sharp decline in investment would augment an economic slowdown. In fact, Malaysia’s capital market has been experiencing large outflows of funds since the surprise outcome of the General Election in early May as well as the current policy changes and measures brought by the new administration led by Pakatan Harapan government; mainly the removal of Goods and Services Tax rate and scrutinising key infrastructure projects. To ensure capital market stability and ample liquidity as well as to support growth, we expect BNM to adopt an accommodative stance and hold the overnight policy rate at 3.25% for the year and perhaps the next as well.

● Meanwhile, we expect the ringgit to remain weak against major currencies. Against the USD we expect the ringgit to test the 4.05-4.10 level in the near term. We are revising our year-end USDMYR target to 4.05 from 3.90.

Source: Kenanga Research - 14 Jun 2018