OVERVIEW

● As widely anticipated the Federal Reserve’s Federal Open Market Committee (FOMC) decided on Wednesday to leave the target range of the fed funds rate at 2.25%-2.50% after a rate hike of 25 basis points (bps) at its last meeting on December 18-19. It's raised interest rates nine times in all since late 2015. All ten voting members of the FOMC voted in favour of the decision.

● The Fed sounded more neutral and said it will be “patient” on future interest rate hikes in its policy statement released after the FOMC decision. This would reinforce expectations that the Fed is almost done raising interest rates. This suggest that in the event of a sharp economic slowdown over the course of this year the Fed would likely be cutting rates at the beginning of 2020. Furthermore, there seemed to be a shift in the language of its intention on adjusting rates with the removal of the reference to “further gradual increases” and including new language saying the Committee would wait to see “what future adjustments to the target range for the federal funds rate may be appropriate.” Meanwhile, US short-term interest-rate futures erased earlier losses and swung higher following the FOMC statement. Contracts tied to the Fed’s policy rate continued to price about a one-in-four chance of a 2019 Fed rate hike, and contracts maturing in 2020 were signalling a small but rising chance of a rate cut thereafter.

● Evaluating appropriate size for balance sheet. The Federal Reserve Chairman Jerome Powell said the Fed is now evaluating "appropriate size of the balance sheet" and when to end its runoff adding that "the ultimate size of the balance sheet will be determined by demand for reserves by banks plus a buffer." Current estimates of reserve demand are higher than previous estimates, he added. As of last Wednesday, the securities portfolio totalled USD3.9 trillion. On September 26, 2007, just before the Great Recession began, the Fed’s securities portfolio only totalled just under USD0.8 trillion. The efforts to reduce the size of its securities portfolio began in October 2017. The plan to put an end to the winding down of Fed’s portfolio came after Fed officials signalled that they were slowing down the pace of policy rate increases in 2019.

● BNM rate decision hinges on growth outlook. As the US Fed beginning to sound more cautious on its outlook on the economy and a more neutral stance on its monetary policy, the emerging economies’ policy bias would likely take a cautious and easy stance. The current environment would give more room for Bank Negara Malaysia (BNM) to adjust its short-term benchmark interest rate lower this year if need be. However, the chances that BNM would cut interest rate is relatively low for now given that the Fed has not indicated that it is fully out of the tightening cycle yet. In the event that the domestic economy would slow sharply, we expect BNM may not hesitate to ease its monetary policy stance. However, given that the growth trajectory remains sustainable and the inflationary trend relatively steady at this juncture, we expect BNM to maintain its accommodative monetary stance and the overnight policy rate at 3.25% in 2019. We forecast this year’s GDP growth to be slightly lower at 4.7% than an estimated 4.8% in 2018.

Source: Kenanga Research - 31 Jan 2019