US DOLLC& CND &INGGIT OUTLOOK

As we enter into 2023, the dollar momentum is poised to lose steam.

THE US Federal Reserve’s (Fed) aggressiveness, in addition to the speed of rate hikes to address inflation, had led to a strong bias towards the dollar. From the start of this year, the cumulative rate hike by the Fed was 300 basis points (bps) to reach 3% to 3.25%. It saw the dollar appreciate by 15.3% as of Oct 25, 2022.

The strong dollar momentum will remain in the the fourth-quarter (4Q) of the year. It will continue to be supported by the rate hikes.

The Fed is poised to further hike the policy rate by 75 bps in November and 75 bps in December. This should see the policy rate settle at 4.5% to 4.75% by end 2022.

Besides the aggressive rate hikes by the Fed, the real yields (Ust10year minus inflation) are deeply negative. It has been in the negative territory since November 2019. Hence, there are limited room for any immediate relief from the strengthening dollar.

Furthermore, the dollar will remain an attractive safe haven as we expect global recessionary fears to deepen in the coming months plus the heightening of the geopolitical tension.

Thus, we foresee that the dollar will overshoot from its fair value in response to its monetary policy tightening. We expect the dollar to strengthen in 4Q.

However, there are concerns around the expensive dollar. While it may keep a lid on import prices and help contain the inflation pressure, a higher dollar will make US exports less competitive.

Plus, developing economies or companies that seek funding in US dollar will face some squeeze as local currencies are needed more to pay off the loans.

As of September, the US dollar real effective exchange rate surged 12% year-on-year – the fastest pace since 2015 and at its highest level since the data was re-indexed back to 100 in January 2006.

Dollar momentum

As we enter into 2023, the dollar momentum is poised to lose steam.

The narrative is of “inflationary pressure” shifting towards “slower growth or recession”. Inflation and rate hikes would have caught up with the economy.

Following more than a year of rising prices, wages are not keeping up. The core inflation – an indicator of how entrenched the inflation is – has grown an average of 0.6% month-on-month (m-o-m) during the January to August period compared with personal income which only grew by 0.4% m-o-m over the same period.

Consumers are dipping into their savings. The personal saving rate in August remained unchanged at only 3.5%, near its lowest rate since 2008. It is well below the pre-covid level of around 9%.

Meanwhile, recession risk has been ramped up since early July when the yields on two-year US Treasury notes jumped above the yields 10-year Treasury notes – a phenomenon known as a yield curve inversion.

Inverted yield curves have historically been a strong economic recession indicator.

Two-thirds of the time, the economy has historically fallen into a recession within 18 months of a yield curve inversion. And the current yield curve inversion is the deepest since 2007, the year before the notorious global financial crisis.

But the sharp economic slowdown will prompt the Fed to slow down its tightening of monetary policy.

This is likely to happen in early 2023. We expect a modest 25 bps hike in January by the Fed. That should see the policy rate settle at 4.75% to 5% in 1Q23.

Although the economy for the first two quarters of 2022 reported negative gross domestic product (GDP) growth based on preceding quarters, the overall full year GDP on annual basis is expected to grow by 2.3% in 2022.

GDP to soften

Looking into 2023, we project the GDP soften to a mere 0.5%, implying several quarters of negative GDP growth based on quarter-on-quarter. Hence, a stronger dollar should peak in 1Q23.

Underpinned by a sharp slowdown or even likelihood of a recession, can the Fed continue its rate hike policy even if inflation is high?

We feel this will be rather unusual. Continued rate hikes in 2023 are not on the cards. Such a move will risk hitting the economy even harder.

Our strong dollar view is likely to peak at 116 in 1Q23. Thereafter, the dollar will start to give up its major gains in 2023 when it move towards a “cyclical decline as the economy tips into a recession.

This would open the door for the Fed to cut interest rates. We are expecting rate cuts to start in 2H23

by about 100 bps. On that note, the dollar should start to slide to 112 in 2Q23 and ease all the way to 101 in 4Q23.

Upward bias on ringgit

The Fed’s aggressive rate hikes in 2022 with the aim to cool inflation had led to a strong upwards bias on ringgit. The currency fell by 13.5% as of Oct 25. This is despite Bank Negara having raised its policy rates by a cumulative 75 bps to reach 2.5% until October 2022.

Expectations are for Bank Negara to raise another 25 bps in November and another 25 bps in January.

This will bring the policy rate back to pre-covid level of 3%.

The ringgit remained weak despite the efforts to stabilise the currency by utilising around Us$9.5bil (Rm45bil) of Bank Negara’s reserves.

The 2Q GDP reported a strong growth of 8.9% year-on-year. And expectations are for the 3Q GDP to perform better than 2Q, projected to hover around 9% to 10% – supported by strong exports and domestic activities. However, the GDP is projected to grow at slower pace in 4Q, to around 5%.

Despite a strong full year GDP of 7.5% to 8.5%, the ringgit is poised to stay weak due to the “dollar play”.

External headwinds plus domestic noises remain a major drawback for the ringgit. Also, the interest rates differentials remain wide, favouring the dollar.

We project the US dollar to ringgit exchange rate in 4Q would be at 4.70 against the dollar.

Peak in 1Q23

The ringgit has seen its weakest valuation against the dollar at 4.88 on March 31, 1998. The upside pressure on the currency remains from both external headwinds and domestic noises. We expect the ringgit to weaken further in 1Q23 to 4.80 against the dollar.

Going forward, we foresee the interest rate differential between Malaysia and the United States to narrow in 2H23.

With a sharp slowdown or recession risk in the United States, we are of the view of potential rate pullbacks by the Fed in 2H23. With an estimated reduction of 100 bps, this would mean that the interest rates differential would drop from a peak of 1.25% to 1.5% to 0.25% to 0.5%.

Besides, the domestic economy would be much settled post the 15th General Election.

This would mean the positive impacts from the 12th Malaysia Plan, foreign direct investments, domestic direct investments, domestic activity, exports and better management of inflation and Budget 2023 should provide the necessary comfort for the economy to expand to 4.5% in 2023.

For FX enquiries, please contact: ambank-fx-research@ambankgroup.com

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