Can US interest rate hikes go on till 2020?

CONTRARY to recent expectations for rate hikes till middle of next year, the Fed has signalled for increases until 2020.

Its projections are made based on expected strong growth in the US for three more years. Would the pace of rate hikes have to slow down sooner, as earnings, boosted by tax cuts this year, get normalised and higher interest costs pose downside risks to earnings, employment and consumer spending?

Fresh data indicates some slowing down, as the trade war deepens. The US merchandise trade deficit for August rose unexpectedly to close to a record of US$75.8bil as exports of food, industrial supplies and autos declined; business equipment orders fell after a strong run, and shipments of those items have slowed.

Total home sales for the San Francisco Bay Area in August fell 10% year on year; sales activity from June to August was the slowest in seven years.

Could the strong US labour market be the result of overspending which has spurred businesses to hire aggressively?

“By next year, it may become obvious to US businesses that they have misjudged the sustainability of this cycle,’’ said Pong Teng Siew, head of research, InterPacific Securities.

“US rates will be quite toppish by next year,’’ said Danny Wong, CEO, Areca Capital.

Some economists have trimmed their estimates for US third quarter growth, which according to a Bloomberg survey, was previously for a median estimate of 3%. Even with a narrowing yield gap of 18.3 basis points between two and 10year Treasury yields, the smallest differential since 2007, fears of recession may be downplayed by some. But the effects of the US fiscal stimulus will be running out of steam by 2020, the escalating trade war and rising rates will impact, among other things, trade, prices and borrowing costs.

“Risks (of recession) are higher this time round,’’ noted Lee Heng Guie, executive director, Socio Economic Research Center.

As US rate hikes are expected to slow down quite soon, hopes for an emerging market (EM) rally are simmering.

Overvaluations in developed markets aside, regional markets could also get a boost from the inclusion of Chinese mainland stocks into the EM indices of the FTSE Russell and MSCI Inc.

Any EM rally may not be sustained; some EMs are plagued by weak fundamentals, high borrowing costs and over-dependence on oil. EM currencies, which recovered on rate hikes, planned reforms and stabilisation measures, remain under threat. EM governments and companies face US$2.7 trillion in dollardenominated bonds and loans through 2025, that need to be paid off or refinanced.

For the rest of this year, over US$200bil of this debt will come due, with another US$500bil for next year.

At the end of 2017, Turkey topped the list for dollar-denominated credit to nonbank borrowers, with a record US$195bil or 23% to gross domestic product (GDP). This was followed by Mexico, Argentina, Indonesia, Saudi Arabia, Russia, Malaysia, South Africa, Brazil, China and India.

However, Mexico, among the top debtors, has “better current account balances and higher foreign exchange reserves”, said Business Insider.

Against continuous US rate hikes, fears of an EM debt crisis are still lurking. Malaysia’s external, government and household debt remain under watch; it will also be under pressure from rising US rates and possible EM contagion.

But the ringgit has performed relatively better than other EM currencies, buoyed by a healthy current account surplus and strong oil prices. While many EMs are raising rates, Malaysia is expected to stay put on rates unless the ringgit weakens significantly.

Low expectation of inflation and slower growth as a result of lower infrastructure spending, are some factors favouring current low rates, said Thomas Yong, CEO, Fortress Capital.

Healthy reserves and absence of fiscal and current account deficits help Malaysia to buffer against reversal of capital flows. Oil price is speculated to hit US$100 per barrel, but the current spike in prices could be short-lived as geopolitical risks subside.

In addition, very high prices, coupled with the impact from escalating trade tensions, will likely dampen global growth and lower demand. Supply threats next year may affect oil prices; non-Organisation of the Petroluem Exporting Countries (Opec), led by the US, may increase output by 2.4 million barrels per day (bpd) while global oil demand is expected to grow by 1.5 million bpd, said Reuters.

A stronger dollar and weaker emerging economies will likely affect demand. With ongoing discussions on likely output increases and outlook for next year, future oil price levels remain uncertain.

Any possible impact and action taken related to President Donald Trump’s criticism of Opec over high oil prices, is on traders’ radar.

Columnist Yap Leng Kuen notes current strong oil prices may be unsustainable.