By Opus Asset Management Sdn Bhd
- Federal Reserve raises 75 basis points (bps) back-to-back, Fed Funds Rate now at 2.5%. The US Federal Reserve (Fed) decided to raise the Fed funds rate by another 75bps in line with consensus, bringing the Fed Funds Rate to a target range of 2.25%-2.5%. The 75bps hike was largely in response to June’s elevated Consumer Price Index (CPI) reading of +9.1% YoY. The Fed did not provide explicit guidance for future rate hikes, with Chairman Jerome Powell mentioning it would be data-dependent without ruling out a larger quantum if inflation remains elevated.
- Fed main goal is taming inflation, even at the cost of economic slowdown. Markets have recently been focused on the recessionary narrative following the release of weak economic data. Although the Fed has acknowledged “that spending and production has softened”, Powell still believes that the currently low unemployment rate (Jun’22: 3.6%), continued job gains and wage growth would allow the Fed to continue hiking even into a “sustained period” of economic weakness.
- Recession fears growing in tandem with deterioration in economic indicators. The current probability of a US recession within the next 12 months rose substantially with the probability now at 47.5% according to a Bloomberg economist survey. This is in line with weak composite Purchasing Managers Index (PMI) numbers for July (47.5) which illustrated a contraction in business activity as the services sector stumbled.
- UST yields reflecting rising recession risks from Fed’s hawkish stance. As the Fed maintained its hawkish stance on inflation, the US yield curve remains inverted especially between the UST2Y and 10Y which was inverted by roughly 20bps. Persistent yield curve inversion normally points to a recession. The 10Y US Treasury is now slightly below 2.80%, compared to 3% in early July and peak of 3.5% in June.
- Malaysian bond market already priced in at least 4 rate hikes. Notwithstanding the Fed rate hikes, we expect Bank Negara Malaysia (BNM) to hike the Overnight Policy Rate (OPR) by 25 – 50 bps by end of 2022. However, we note that the Malaysian bond market has already priced in more than 4 rate hikes (total 100 bps), with the 3-Year MGS currently at 3.50% vs current OPR of 2.25%. As such, we do not expect the Malaysian bond market to react to the Fed rate hikes in a volatile manner. Furthermore, rising risks of a recession in developed markets and a slowdown in growth caused by further rate hikes could lead to a cap on bond yields.
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