FEARS of the US dollar flowing out of emerging markets such as Malaysia following the rise in interest rate by the Federal Reserve has receded.
In fact after the Federal Reserve raised interest rates by a quarter percentage to 1.5% to 1.75%, the dollar index slipped to below the 90-point mark. The dollar index measures the greenback against a few major currencies.
The ringgit is at RM3.90 against the US dollar and dealers are looking at further strengthening of the local currency against the greenback.
Textbook economics theory would suggest that a rise in interest rates would be accompanied by the strengthening of the currency. But it is not happening as far as the US dollar is concerned, this time around.
The scenario is very unlike the situation in May 2013 when the Federal Reserve chairman Ben Bernanke announced that the US would gradually reduce its “printing of money” exercise.
After his announcement, emerging market currencies took a beating as there was an outflow of funds coupled with the US dollar strengthening. The episode has been labelled as "Taper Tantrum".
The ringgit, which was at less than 3.20 to the dollar went to about the 4 mark against the dollar some 20 months later. The falling oil price contributed to the weak ringgit.
In November 2016, when Donald Trump won the US presidency, the ringgit weakened again, sliding to a low of 4.49 against the dollar.
However since January last year, the uncertainty of the US economy under Trump has caused a weakening of the dollar.
A currency dealer said that the weak dollar is all about market expectations and the exuberance on the greenback in the run up to the press conference by Federal Reserve chairman Jay Powell.
He said the US dollar strengthened in recent weeks over expectations of the Federal Reserve making four rate hikes in 2018, something which Powell has dismissed.
“Furthermore the US is going to bust its Budget, adding US$300bil in spending for the next two years. The US is seeking another 10 years to balance its budget, something which was not what Trump planned when he was on the road to presidency.
“Adding to the woes of the budget deficit is the protectionism policies that the US is adopting which does not look for the economy,” said the dealer.
Powell in his maiden Federal Open Market Committee (FOMC) meeting on Wednesday night alluded to three interest rate hikes next year and was bullish of the US economy.
Unemployment in the US is at 3.6%, the lowest since the 1960s and core inflation is expected to hit above 2% next year. By mid-2020, the Fed interest rate in the US is expected to be about 3.5%.
The gradual rise of rates in the US adds credence to the views of local economists who feel that Bank Negara will only the rates towards the second half of this year. At the moment, Bank Negara has set a rate of 3.25 %.
Alliance Bank chief economist M. Manokaran Mottain has anticipated Bank Negara to raise the rates towards the second half of the year.
He said that historically, the spread between the US and Malaysian rates were 200 basis points.
“The spread can be lower but the trigger for Bank Negara to raise rates is if the spread comes close to 100 basis points,” he said.
Generally the interest rate spreads between emerging markets and the US is between 1.5% and 2.5%.
At the height of the global financial crisis, the spread was up to 400 basis points because some countries resorted to raising rates to prevent the flight of capital from emerging markets.