The State of the Nation: What the Fed’s 75bp Hike and Near 4% Terminal Rate Mean for the OPR

If Bank Negara Malaysia’s eight-member Monetary Policy Committee (MPC) raises the overnight rate (OPR) by 25 basis points (bps) at its next meeting scheduled for July 6, it will mark its first increase consecutive run since mid-2010, when interest rates normalized following the recovery from the 2008 global financial crisis. It will not be the first central bank to do so.

Compared to just a month ago, more economists now (at the time of writing) believe a 25 basis point hike will occur in July, but many still think a break is possible in July. before the Hari Raya Aidiladha celebrations. In any case, at least one more rate increase (if not two) should take place by the end of the September 8 meeting to bring the OPR to at least 2.25% (if not 2.5%), based on consensus data.

“Our house also shifted Bank Negara expectations towards early rate hikes. We now expect the central bank to tighten 25 basis points in July and another 25 basis points [to 2.5%] before the end of the year. For 2023, [we see] another hike of 50 basis points in total to bring the OPR to 3%,” the experts at Maybank Investment Bank Research wrote in a June 16 note.

For the record, economists who correctly predicted that the MPC would start normalizing rates with a 25 basis point increase in May were in the minority. Those who believe a cumulative 50bp hike will occur via two hikes in the three remaining MPC meetings this year to bring the OPR to 2.5% by November 3 (the last MPC meeting scheduled for 2022 ) were also in the minority at the time of writing.

Despite the U.S. Federal Reserve’s outsized hike, no one expects a 50 basis point hike to happen all at once, with the OPR only expected to rise closer to 3% by now. the middle of 2023. Bank Negara Governor Tan Sri Nor Shamsiah Mohd Yunus has repeatedly stated that any adjustment of the OPR will be “measured and gradual to support sustainable economic growth, while ensuring the stability of price”.

It remains to be seen whether more economists will revise their expectations in the next fortnight after the Fed began June 15 to cut its balance sheet by US$9 trillion (quantitative tightening), proceeded with its rate hike the most aggressive since 1994 (+75 basis points) to bring its benchmark funds rate back to a range between 1.5% and 1.75%, and guided the possibility of another hike of 50 basis points or 75 basis points at the next rate officials meeting on July 27 – if data shows that US inflation has not been brought under control.

Moreover, compared to the year-end terminal (equilibrium) rate of around 2% in mid-March, the Federal Open Market Committee’s (FOMC) “dot chart” now shows rates ending the year closer to 3.5% (3.4%) and moving closer to 4% (3.8%) in 2023.

“From a local rate strategy perspective, we think the hurdle is actually not high for the first rate hikes by Bank Negara to [between] 2.5% and 2.75%. But it will likely face a higher bar to go further due to growing external macro headwinds,” says Winson Phoon, head of fixed income research at Maybank Investment Banking Group in Singapore.

While Bank Negara only started raising interest rates in May, ringgit yield curves “have already risen significantly in tandem with the hawkish price revision in US rates markets,” Phoon said. While yields on Malaysian government securities (MGS) “have fully priced in the OPR increases to 3.25%”, he estimates that two or three more rate hikes of 25 basis points each “cannot have may not matter much to bond yields, and US rate volatility has been and will remain the main driver.

Yields on the benchmark MGS 10-year (3.58% coupon), which were at 3.67% at the end of February before the Malaysian bond market experienced (in March) its first net foreign outflow since November 2021, had fallen to 3.85% at the end of February. March and 4.38% at the end of April before falling back to 4.17% at the end of May, according to data from Bank Negara. Closing at 4.36% on June 16, trade yields had a 236 basis point spread over the OPR and a 108 basis point spread over the 10-year US Treasury yields which were at 3, 28% at the time of writing.

“Although MGS yields have adjusted quickly, the impact is limited to issuers and investors of Malaysian government debt securities. In contrast, a change in the OPR would affect banks’ lending and deposit rates, with far-reaching consequences for consumption and investment activities in the economy, given the dominance of banks in the country’s financial system,” says Dr. Yeah Kim Leng, Professor of Economics at India’s School of Business. Sunway University.

Bank Negara’s rate decision will be (as it puts it) “data dependent”. Experts who noted that the central bank’s rate hike in May “also came during a period of ringgit weakness”, however, believe pressure on the ringgit would increase further if Bank Negara is seen as lagging behind. monetary normalization as more central banks raise interest rates.

“If the rate hike means Bank Negara is confident of a firmer growth trajectory, not doing so could be read [negatively]“, Says an observer.

Since the beginning of the year, the ringgit has weakened by 5.5% against the American dollar (4.402) and by 2.9% against the Singaporean dollar (3.1766), whose government is fighting inflation thanks to to the strength of its currency.

With more than 40 central banks around the world already raising interest rates, it’s no wonder pundits say the days of zero rates are numbered, even though there remain significant headwinds to global growth. . On June 16, just after the Fed hike, the Swiss National Bank surprised the market with its first rate hike in 15 years (+50 basis points to -0.25%). The Bank of England raised interest rates by 25 basis points to 1.25% while the central bank of Taiwan raised its key rate by 12.5 basis points to 1.5% (after a hike 25 basis points from a historic low of 1.125% in March). The European Central Bank, which called an emergency meeting on June 15 to discuss market conditions, is expected to raise interest rates at its next monetary policy meeting scheduled for July 21.

The Bank of Japan, however, kept its benchmark rate at zero on June 17, driving the yen lower against the US dollar despite a rare statement that added “exchange rates” to a list of risks requiring attention. the bank. Prior to the Fed’s rate hike, China’s central bank had kept medium-term loan (MLF) interest rates unchanged at 2.85% for a fifth month, while Hong Kong – which had more than 460 billion in foreign exchange reserves at the end of May – would have spent more money to maintain the peg of its currency to the US dollar in place since 1983.

Prior to a 25 basis point cut to 3% in May 2019, Malaysia’s OPR had been at 3.25% since January 2018. This is only after four consecutive cuts totaling 125 basis points between January and July 2020 that the OPR fell to an all-time high of 1.75. %, where it remained for about 22 months before some “excess housing” was removed on May 11. Bank Negara’s first rate hike since January 2018 came two days before stronger-than-expected 1Q2022 GDP growth of 5% YoY, allowing it to affirm the official GDP growth target of 5, 3% to 6.3% for this year.

While Nor Shamsiah declined to comment on whether the MPC was considering a 3% terminal rate by mid-2023 when asked to comment on May 13, she said it was “very important” that the monetary policy is recalibrated “with care now to avoid having to be aggressive over time, which is the case with certain central banks which are exiting from very low rates”.

In other words, Bank Negara does not want to have to catch up if the data points show that the economy no longer needs the current level of monetary accommodation.

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