Fed unwinding a sign of confidence in world economy

THE decision by the US Federal Reserve to start unwinding its US$4.2 trillion of bonds, despite inflation remaining low, is a sign of confidence in the growth prospects of the world economy.

However, the rebound in the greenback, if sustained in the near term, could cast a slight downward pressure on emerging market currencies, including the ringgit.

“There may not be a sharp reversal of the ringgit against the US dollar, due to improved economic prospects this year,’’ said Nor Zahidi Alias, the chief economist of Malaysian Rating Corp.

“The recent appreciation of the ringgit against the US dollar was partly due to negative sentiment surrounding the greenback amid low inflation numbers, political noises and global geopolitical concerns.

“As such, the rebound in the US dollar would likely mean slower appreciation of the ringgit, or a slight depreciation in the near term,’’ said Zahidi.

“The Fed’s great unwinding, along with continued rate hikes, will likely result in a stronger US dollar, more attractive US bond yields and capital inflows, as well as more demand for US dollar denominated assets.

“It is inevitable that regional financial markets and currencies will be impacted but improved economic and financial fundamentals, as well as strengthening growth prospects should cushion against capital reversals and induced financial volatility,’’ said Lee Heng Guie, the executive director of Socio Economic Research Center.

Starting next month, the Fed will begin to reduce its US$4.2 trillion in holdings of US Treasury bonds and mortgage-backed securities by initially cutting up to US$10bil each month from the amount of maturing securities it reinvests.

That action will start a gradual reversal of the three rounds of quantitative easing (QE) the Fed pursued between 2008 and 2014 to stimulate the economy after the 2007-2009 financial crisis, according to a Reuters report.

(QE refers to the Fed’s purchase of government securities from the market in order to lower interest rates and increase money supply).

The limit on reinvestment is scheduled to increase by US$10bil every three months to a maximum of US$50 bil per month until the central bank’s overall balance sheet falls by perhaps US$1 trillion or more in the coming years, the Reuters report said.

“The gradual reduction in the Fed’s bond holdings will likely have little impact on the economy in the near term, as the world economy has improved and become more stable.

“As most major equity indices are trading at multi-year highs, investor sentiment may turn cautious in the near term,’’ said Fortress Capital CEO Thomas Yong.

“It is unlikely to shock the market as the size and pace of the Fed’s balance sheet reduction will not be as large and as rapid as the QE that was initiated during the global financial crisis.

“The unwinding of stimulus will be offset by an easier short term interest rate path to avoid a significant impact on the cost of funds and global financial conditions,’’ said Lee.

An article entitled “Malaysia’s reserve buffer seen as among weakest in Asia,’’ has stirred a lot of reaction in Malaysian circles.

“They have only looked at one side of the equation. As a country running large current account surpluses, we are a net creditor to the world, amassing claims either in the form of reserves or other financial assets, or in the form of physical assets we own in other countries, or share of businesses outside the country,’’ said Pong Teng Siew, the head of research of Inter-Pacific Securities.

Therefore, one just cannot look at claims in the form of reserves.

“In the same breath, they ignore the very high debt to gross domestic product ratio (more than 100%) of Singapore that owns assets that far outweighs its debts.

“I wonder why they are willing to concede that point in their assessment of Singapore, but not in the case of Malaysia,’’ said Pong.

Bank Negara, in its rebuttal, said international reserves was not the only means to meet external obligations, and that since 2015, Malaysia’s external assets had exceeded its external liabilities.

Malaysia’s net international investment position of 3.3% of gross national income strengthens its resilience to a variety of shocks, including potential outflows, the central bank said.

“Malaysia is in a position of strength to cope with the potential induced volatility and risks associated with the Fed’s normalisation and shrinking of balance sheet.

“A flexible exchange rate policy, strong and stable financial system, unencumbered foreign reserves against short term liabilities, and deepening capital market should buffer Malaysia against the impact of the Fed’s great unwinding.

“The ringgit stabilisation measures, including the banning of ringgit trading in offshore markets, should help ease the ringgit exchange rate volatility,’’ said Lee.

Columnist Yap Leng Kuen hopes for sustained economic growth.