On: February 3, 2023 In: Blog, Fixed Income, Knowledge Centre
  • Federal Reserve slows hike to 25 basis points (bps); current Fed Funds Rate at 4.50% – 4.75%. In light of moderating inflationary pressures, the US Federal Reserve (Fed) decelerated further by opting for a 25bps increase to bring the Fed Funds Rate (FFR) to a target range of 4.50% – 4.75% in January. The smaller 25bps quantum was unanimous among Fed voters and in line with the market consensus for the first FOMC meeting of 2023, although there remains a divergence between the Fed’s hawkish, cautious stance and market expectations of a rate cut later in the year.
  • Bank of England (BoE) and the European Central Bank (ECB) both hiked 50bps. Despite signs of declining inflation in Europe, both the BoE and ECB opted to maintain the quantum of rate hikes at 50bps each. We note however that the BoE (current rate: 4%; expected terminal rate: 4.5%) is closer to its terminal rate than the ECB (current rate: 2.5%; expected terminal rate: 3.5%), mainly attributable to the BoE beginning its rate hike cycle earlier than the ECB as well as a higher risk of recession in the United Kingdom (UK) in comparison with mainland Europe.
  • Fed biased towards caution in first FOMC meeting, with modest changes in meeting statement. Key takeaways from the FOMC statement include a change in language from “In determining the PACE of future increases” to “In determining the EXTENT of future increases” which suggests the Fed has a clearer outlook on the FFR terminal rate. Furthermore, the Fed also noted that inflation “has eased somewhat but remains elevated”, compared to previous cases where “elevated” alone was the Fed outlook on inflation. We note that despite the dovish change in language, Fed chair Jerome Powell was quick to reiterate the Fed’s commitment to combating inflation while emphasising his view of no rate cuts in 2023.
  • Bank of England (BoE) and the European Central Bank (ECB) remained committed in fighting inflation, although BoE may ease on rate hike path due to economic uncertainty. Both the BoE and ECB noted an improvement in the inflation outlook but stayed adamant that inflationary pressures still remained and it was too soon to declare victory. The key difference is that the United Kingdom is more likely to enter a recession compared to mainland Europe. Europe has benefited from cheaper energy prices due to an unusually warm winter, while we note that the UK economy could tilt into recession due to the additional negative impact from Brexit.
  • Global inflation outlook has moderated in recent months, but remains far from respective central bank targets. Supporting the slightly more dovish shift in Fed language was the deceleration in the preferred Personal Consumption Expenditure (PCE) measure to +5.0% YoY in Dec’22, after peaking at +7.0% YoY in Jun’22. Despite the improvements in inflation indicators, price levels (Dec’22 PCE: +5.0% YoY) are more than double of the Fed’s PCE target of +2.0% YoY. Similarly, inflation in the UK (Dec’22 inflation: +10.5% YoY) and the Eurozone (Jan’23 estimated inflation: +8.5% YoY) remain substantially higher than the 2% target of both central banks. In view of the above, we do not discount the possibility of further volatility arising from the divergence between central bank hawkishness and dovish market views as unfavourable inflationary developments could lead to market overreactions in the near term.
  • Malaysian Government Securities (MGS) yields fell in line with the global markets, as fixed income continued its rally since the beginning of 2023. The 25bps Fed rate hike notwithstanding, Bank Negara Malaysia (BNM) had already paused its rate hikes in its first Monetary Policy Committee (MPC) meeting of 2023, citing slowdowns in the external environment. Thus, our house view calls for only 1 more rate hike of 25bps in Malaysia, although this is dependent on inflation and growth declining. Malaysian MGS yields were lower following the Fed decision, although we note this was attributable more towards a general market rally than a Fed-specific catalyst. The rising risks of a slowdown in developed markets and a possible spike in geopolitical tensions remain as factors that could lead to a cap on bond yields from the Malaysian perspective progressing further into 2023.

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