By Opus Asset Management Sdn Bhd
• Federal Funds Rate raised by 50bps to 1%. On Wednesday, the US Federal Reserve (Fed) increased the Fed funds rate by 50bps to 0.75%-1.00%. The rate hike was contained within expectations, as some market participants were concerned with the possibility of larger rate hikes as high as 0.75%-1.00%. Of note, Fed Chairman Powell played down the prospects of a 75bps rate hike. As such, the markets reacted positively, as a rally in equities ensued, while bond yields declined. The 10y UST (10-year US Treasury) declined 10 bp (10 basis points, or 0.10%) from the intraday high of 3.01%.
• Fed reveals guidance on balance sheet reduction beginning on 1-Jun-2022. As expected, the Federal Reserve explained the details of the balance sheet reduction, in the following amounts:
|TOTAL MONTHLY CAPS ON SECURITIES REDUCTIONS|
|Treasury Securities||Agency Debt and Agency MBS|
|Jun-Aug 2022||$30 billion||$17.5 billion|
|From Sep 2022||$60 billion||$35 billion|
Nonetheless, we note that the Federal Reserve has qualified that these amounts are subject to possible change. The Federal Reserve will continue to monitor the economic effects of these securities reduction and will slow the reduction in its balance sheet when necessary.
• Inflation management to remain a difficult task, compelling rate increases of 50bps to be the norm for now. The Federal Reserve remains wary of inflation risks, citing external factors of the Russia-Ukraine war and China’s lockdowns as factors that will lead to both higher prices and a slower economy. US headline inflation in Mar-2022 grew 8.5% yoy (year-on-year) while core CPI rose 6.5% yoy. In addition, domestic factors including low housing supply and high demand is causing much higher prices in the US housing market. The US existing home sales median housing price rose a massive 15% yoy in March. As a result, mortgage rates rose to 5.1% by end-April, up a significant 2% since the beginning of the year. In light of these, the 50bps rate hike by the Federal Reserve appears warranted, and rate hikes are likely to continue in steps of 50bps rather than the usual 25bps.
• A strong US economy with early signs of easing economic activity. Federal Reserve Chairman Powell explained that the economy is strong due to a tight labour market while the average US citizen has amassed significant savings during the pandemic. Nonetheless, the withdrawal of easy monetary policy in an aggressive manner continues to present downside risks to growth going forward. Higher leverage to the housing market implies a stronger contraction to future growth as interest rates rise. Already, the leading economic indicators on manufacturing and services from the Institute of Supply Management (ISM) fell below expectations in April, declining 13%-15% from its peak in March. The current probability of a US recession has increased to forecasts of 25% to 30%, doubling from 4Q2021. Higher interest rates in the US are already taking its toll on the economy.
• US interest rates transmit to Malaysia’s markets, causing an overreaction and attractive valuation. The US-Malaysia interest rate gap now stands at 75bps, close to its recent May 2019 low of 50bps. A lower gap caused by rising US interest rates tend to result in capital flows out of Malaysia to the US. However, present conditions in Malaysia’s markets suggest some overreaction. Back in 2019, the USDMYR was still trading below 4.20, as compared to today’s 4.33-4.34. In addition, the 10 year MGS (Malaysian Government Security) was trading below 4% in May 2019 as compared to the present level of near 4.40%. The sharp reaction in Malaysia’s market could also be partly due to the April 2022 EPF withdrawal scheme. This creates an opportunity in the Malaysian market because the EPF expects this special withdrawal to be the final one, while an improving economy with declining unemployment rate will eventually lead to rising inflows to EPF. Furthermore, at the present yield, the MGS market is pricing in the OPR at 3.25%, which is very high compared to the present OPR of 1.75% and our expectation for an OPR rate hike of 25bps in 2H2022.
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