On: November 3, 2022 In: Blog, Fixed Income, Knowledge Centre
  • Federal Open Market Committee (FOMC) raised the Fed Fund Rate (FFR) by 75 basis points (bps) to 3.75-4.00%; Monetary Policy Committee (MPC) hiked Overnight Policy Rate ((OPR) by 25bps to 2.75%. As anticipated, the US Federal Reserve (US Fed) has lifted the FFR to 3.75-4.00%, its fourth consecutive 75bp rate hike since Jun this year, as headline inflation remains high. Malaysia’s MPC also remained on the rate hike path with a 25bps increase to 2.75%. Both the US Fed and MPC kept the focus on the impact of elevated headline inflation for their respective countries, mainly attributable towards higher food and energy prices, recovering labour markets as well as geopolitical tensions between Russia and Ukraine. As inflation is likely to remain elevated, we expect Malaysia’s OPR to reach 3.25% in 1Q2023, while the US emphasis on continued rate hikes suggest the FFR may reach 5% by 1H2023.
  • FOMC reaffirms stance to curb inflation, with a target of 2%. We note that US Fed reaffirmed its stance in curbing inflation with a target of 2% inflation over the longer run and expects ongoing increases in the US FFR will be appropriate to the target inflation rate. Going forward, the Fed will consider the impacts of cumulative monetary tightening, including the time-lags of the monetary policy on economic activity and inflation, and economic and financial developments, to determine the future pace of tightening. The fact that the time lag has been mentioned implies the Federal Reserve cannot hastily change the interest rate trajectory and will remain on track for a while on its hawkish stance, even if the size of rate hikes going forward may reduce from 75bps to 50bps, or less over time. As such, the US emphasis on continued rate hikes suggest the Fed Funds rate may reach 5% by 1H2023.
  • Malaysia’s headline inflation exhibited signs of a peak in 3Q22. In line with BNM’s projection for headline CPI to moderate after 3Q22, Malaysia’s September CPI (+4.5% YoY) declined slightly from the peak in August (+4.7% YoY) despite elevated food prices. Looking forward, continued subsidies from an expansionary Budget 2023 coupled with the slowing external economic environment could cap the extent of rising inflation in Malaysia, although there is upside risk from global commodity price developments. As such, inflation is likely to remain a concern of the central bank as we head into 2023, where we expect Malaysia’s OPR to reach 3.25% in 1Q2023.
  • Fed to continue reducing holdings of Treasury securities. In terms of the Fed’s balance sheet, it will continue to reduce holdings of Treasury securities, and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet. The Fed’s balance sheet is decreasing gradually as the Fed’s total assets was down to US$8.7 trillion currently, from its peak of almost US$9.0 trillion in April 2022. The balance sheet reduction will continue to exert upward pressure on bond yields.
  • Domestic and foreign political developments may lead to bond market volatility in November. Apart from interest rate decisions, the upcoming US midterm election and Malaysian General Elections 15 (GE15) may result in volatility depending on the spillover of election results into financial markets. Within the Malaysian context, political instability from the undesirable outcome of a hung parliament or weak majority could potentially send MGS yields higher. However, we view any market reaction would be short term as the market will ultimately revert to fundamentals.
  • Hawkish Fed talk led to surge in US Treasury (UST) yields, with Malaysian markets not fully immune. The US markets reacted adversely to the fading possibility of a quick Fed pivot with the rate-sensitive 2-year UST swung upward ~ 20bps, but closed 7 bps higher. Malaysian markets in turn also saw a slight shift upwards across the MGS yield curve, mainly due to reaction to UST, but rather unaffected to the OPR hike which was largely expected and priced in. In our view, the rising risks of a recession in developed markets, slower OPR hikes and manageable inflation in Malaysia could lead to a cap on Malaysian bond yields.

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