Sharp decline is USD indicates US Feds will increase Funds Rate - Manokaran

WEEKLY MARKET ANALYSIS BY MANOKARAN MOTTAIN

THE benchmark KLCI Index edged higher last week to 1,500.33 points (+5.3points or +0.35%) due to follow through buying of portfolio rebalancing exercises by institutional funds.

Nevertheless, there was a slowdown in trading activities ahead of the long Chinese New Year holiday weekend with the average daily value traded falling by 12% over the past week to RM1.92 billion, which is roughly in line with its past 100-day average daily trading value of RM1.90 billion.

In the bond market, US bond yields continue to fall after the release of December 2022’s Producer Price Index (PPI) fell larger than expected by 0.5% against economists’ expectation of a 0.1% decline.

This is a strong signal that inflationary pressures have peaked at the wholesale level and this lends credence to the market that the US Federal Reserve may cut the quantum of increase for the Federal Funds Rate to 25 basis points from 50 basis points at its upcoming meeting on 31 January – 1 February 2023.

The 10-year US Treasury (UST) yields fell by a meagre 2 basis points last week to 3.48% from 3.50%. This reduced the total yield gains over the past 21 weeks to 45 basis points.   

The UST 2-year yields similarly declined by 4 basis points to 4.18% from last Friday’s close of 4.22% and the yield curve inversion between the UST 2-year and 10-year notes continues into its 28th consecutive week. This caused the yield spreads to narrow slightly by two (2) basis points to -70 basis points from -72 basis points in the week before. The long-term average of the yield spread for both UST is +0.92% or +92 basis points.   

Buying activities in the local bond market continue to surge over the past week with the 10-year MGS bond yields dropped by a whopping 22 basis points to 3.72% last Friday after Bank Negara Malaysia (BNM) kept the Overnight Policy Rate (OPR) at 2.75% following its latest Monetary Policy Committee (MPC) meeting last week. The latest result kept the yield spreads between both countries’ 10-year bonds at 24 basis points.  

ECONOMICS

Prime Minister Datuk Seri Anwar Ibrahim said the government will be focusing on finding a solution to lower the prices of raw materials. This will also include ensuring sufficient production as well as supporting domestic producers of eggs, chicken and vegetable products. He added that confidence from international investors from Europe, China and the US has improved causing the Ringgit to strengthen and helping reduce import costs.

The 2023 Edelman Trust Barometer indicated that only 35% of Malaysians polled said they and their family would be economically better off in five years’ time. The latest result was over 20% lower than last year’s reading and is also the all-time low reading for the country since the survey started 23 years ago.   

Bank Negara Malaysia’s international reserves increased to US$114.9 billion as at 13 January 2023 from US$114.6 billion on 30 December 2022. The reserves position is sufficient to finance 5.3 months of imports of goods and services and is 1.0x the total short term external debt.

Bank Negara Malaysia’s MPC kept the OPR at 2.75% to allow it time to assess the impact of its previous OPR hikes on inflation and the economy. At the current OPR level, the stance of monetary policy remains accommodative and supportive of economic growth and further hikes would be data dependent. The MPC will continue to calibrate the monetary policy settings to balance the risks to domestic inflation and support sustainable growth. 

CURRENCY

The Ringgit continued to its rise against the US Dollar last week gaining another 1.1% to end at RM4.2829 / USD1.00 (-5.1sen) foreign investors continued to switch out of the Dollar into other currencies ahead of the expected end of the interest rate hike by the US Federal Reserve and the rising risk of a recession in the US.     

The Ringgit also generally performed better against the other major currencies over the past week. The local currency gained against the Singapore Dollar to RM3.2491 / SGD1.00 (-3.0sen), the Japanese Yen at RM3.2810 / JPY100 (-8.7sen) and the Euro at RM4.6583 / EUR1.00 (-3.9sen). The Ringgit was marginally weaker against the British Pound at RM5.3042 / GBP1.00 (+0.5sen).  

MY OPINION

The local stock market received a shot in the arm when BNM kept the OPR at 2.75%. However, trading activities slowed down – especially towards the end of the week as traders generally do not want to hold large positions over long holiday weekends.

As per my earlier expectations, the market will test the 1,500 points psychological barrier before attempting to challenge the next resistance level at 1,520 points. Barring any unforeseen developments, I expect the overall market would remain range bound in a +/- 20 point range until end February when the revised Budget 2023 would be tabled on 24 February 2023.

The aggressive buying into the bonds by both the local and foreign investors helped to push the prices higher and yields to contract but the yield spreads between our local 10-year MGS yields and 10-year US Treasury Bills have narrowed significantly to just 24 basis points.

Nevertheless, I am maintaining my view that I doubt the MGS yields can potentially decline by a huge amount from hereon in light of the tight yield spreads and the FOMC meeting later this month whereby another rate hike of between 25-50 basis points is expected.     

In the currency market, the decline in the US Dollar was much sharper than I expected especially when the upcoming Federal Reserve Open Market Committee meeting is happening next week.

It indicates that the US Federal Reserve will increase the Federal Funds Rate by a lower than expected 25 basis points and/or pausing the upcycle earlier than expected with a reduction in the terminal interest rate to below 5.0%.

In light of the weaker sentiments for the US Dollar, I am adjusting my view that the Ringgit will trade between RM4.25 and RM4.30 against the US Dollar in the coming week.

The European Central Bank will also be announcing its interest rate decision on 2 February 2023 with the market generally expecting a 50 basis points hike.

In addition, economists expect the ECB to raise its interest rate to 3.25% before the middle of the year after ECB chief Christine Lagarde said the ECB will still need to continue hiking interest rates at a steady pace to prevent inflation from being entrenched in the economy. Therefore the Euro may rebound against other major currencies in the coming months. - DagangNews.com

Manokaran Mottain has been an economist with a number of financial institutions is now managing his own firm, Rising Success Consultancy Sdn Bhd