The US Fed finally delivered what the market has been expecting – a rate cut. However, the reduction was less than what was expected. Additionally, Chairman Powell’s emphasis that the cut only serves to “insure against downside risks” but did not signal the start of an easing monetary policy cycle, has disappointed the market. Powell went on to describe the outlook of the US economy, which grew at a healthy pace in the first six months of 2019, as “favourable”.
We think the US economy remained generally robust in 1H2019 as evidenced by an over 4% growth in personal consumption expenditure. The headline GDP growth was also above market expectation in 2Q2019, albeit slower than in 1Q2019. This, however, does not mean that possible weaknesses in 2H2019 will prevent the Fed from trimming the rates further. Recent macro releases look less comforting i.e. the leading index contracted at the fastest pace since 2016, gross private domestic investment slumped by the most since 2015 in the second quarter and yield curves continue to invert.
The rate cut will have important repercussions on capital flows into emerging markets. For example, declining net foreign outflows from the Malaysian bond market in 1H2019 is partly associated with the outlook on the weaker greenback on the back of rate cuts that are expected to happen in 2H2019 in the US. The Malaysian bond market recorded net foreign outflows of RM2.2 billion in the January-June 2019 period (1H2018: outflows of RM20.9 billion). Combined net foreign outflows from the equity and bond markets also shrank to RM6.9 billion compared with 1H2018’s outflows of RM27.7 billion.
Going forward, we expect annual cumulative foreign flows into local bonds to improve from their levels in 2016-2018. A further reduction in the Fed Funds rate, if this takes place in 2H2019, will provide more room for Bank Negara Malaysia (BNM) to adjust the Overnight Policy Rate (OPR) downward again, if necessary, in the future. Although our base case scenario calls for the OPR to remain at status quo for the rest of the year, we do not rule out the possibility of another downward adjustment in 2020 if macroeconomic conditions deteriorate. Such prospects will increase the appeal for local bonds due to their attractive yields and Malaysia’s benign inflation outlook. Hence, it will mitigate some of the outflows that could happen in 2H2019 due to rising concerns over the US-China trade war and FTSE Russell’s possible decision to exclude Malaysian government bonds from its global bond index. We expect the 10y MGS yield to hover between 3.5%-4% in 2H2019.
Contacts:
Nor Zahidi Alias, +603-2717 2936/ zahidi@marc.com.my
