Between hawks and doves

The Fed’s tone of “inflation has eased somewhat but remains elevated” to Bank of Canada’s view of assessing the impacts of the substantial monetary policy tightening already undertaken, suggests that most central banks are nearing the end of the rate hike cycle if they have not pressed the pause button just yet. — Bloomberg

THE last couple of weeks were one of the busiest for central banks around the world, as several major central banks moved the needle up with rate hikes ranging from 25 basis points (bps) to as much as 50 bps.

As we are aware, the US Federal Reserve (Fed) raised the Fed fund rate (FFR) by 25 bps – the smallest increase since rate hikes started in April last year, to between 4.50% and 4.75%.

This was followed by back-to-back increases by the European Central Bank (ECB) and Bank of England (BoE), which raised rates by 50 bps each to 2.50% and 4%, respectively.

All in all, since the rate hikes were initiated to fend off inflationary pressure, the Fed mainly has raised rates by as much as 450 bps, the BoE by as much as 390 bps and the ECB by 300 bps.

Other than these three main central banks, since the start of the year, a few other central banks have raised rates and they include the Bank of Thailand, Reserve Bank of Australia, Bank of Korea, Bank of Canada, Bank Indonesia, and the Reserve Bank of India’s move of 25 bps each to 1.5%, 3.35%, 3.50%, 4.50%, 5.75% and 6.50%, respectively.

Meanwhile, the Philippines’ central bank, Bangko Sentral ng Pilipinas (BSP), raised rates by 50 bps on Thursday to 6%, after the January inflation print surged 8.7% year-on-year (y-o-y).

The BSP is now the most aggressive central bank in the Asean region, having raised rates by 400 bps since the start of the rate hike journey in May last year.

The less aggressive rate hikes by many central banks since the start of the year are not surprising, as they were also some central banks that left rates unchanged, including Malaysia’s move to keep the overnight policy rate (OPR) at 2.75%.

Joining Bank Negara in standing pat were other central banks from Egypt, Tunisia, Brazil, the Czech Republic, Poland, Turkey, Kazakhstan, Kenya, Ukraine, Albania and Norway.

Indonesia too joined this group when it held its seven-day reverse repurchase rate unchanged on Feb 16, citing lower inflation expectations as headline inflation eased to 5.3% y-o-y in January from 5.5% in the preceding month.

Less hawkish tone

The Fed’s tone of “inflation has eased somewhat but remains elevated” to Bank of Canada’s view of assessing the impacts of the substantial monetary policy tightening already undertaken, suggests that most central banks are nearing the end of the rate hike cycle if they have not pressed the pause button just yet.

For central banks that have decided to leave rates unchanged in their last policy meeting, the executive board of Norges Bank probably is the most appropriate to quote, as the Norwegian central bank took the view that “global inflation is already at or close to its peak”.

This in any way does not mean that there would not be further rate hikes, as some central banks that paused in their latest meetings also hinted that rate hikes may resume in the following meetings as the impact of previous rate hikes weaves into the economy.

This stance was also taken by the Monetary Policy Committee (MPC) in its latest assessment of Malaysia’s OPR.

According to the MPC, the decision to pause its January meeting will “allow the MPC to assess the impact of the cumulative past OPR adjustments, given the lag effects of monetary policy on the economy”.

What’s next?

While the 2% inflation target remains the Fed’s objective, the tight labour market is another spanner in the works for the Fed to decide when it will hit the pivot point.

The January 2023 labour market report was completely off the charts with a blistering 517,000 new jobs created while the unemployment rate hit 3.4% – the lowest in 53 years.

The only consolation for the Fed was that hourly wages grew at a much slower pace of 4.4% y-o-y.

The January 2023 headline and core inflation prints, which came in at 6.4% and 5.6% and marginally higher than market expectations of a 6.2% and 5.4% increase, respectively, have also thrown in added uncertainty, as despite some easing, inflation remains persistently high.

For now, the Fed is expected to raise its FFR by at least another 25 bps each time in its next three meetings to reach the pivot point of 5.25% to 5.50% by June 2023, before hitting the pause button.

With the economy expected to hit a soft patch, and likely even entering a mild recession, the market is already pricing in expectations that the Fed will cut the FFR by 25 bps by December 2023 to end the year at 5% to 5.25%.

The ECB is expected to raise rates by another 50 bps in March, followed by potentially another 25 bps or 50 bps in May before hitting the pause button.

As for the BoE, the benchmark rate is expected to continue to rise but the pace of increase may be slower than the preceding hikes of 50 bps each, as the central bank sees inflation to fall to 4% this year, exactly at the point where the UK benchmark interest rate is at now.

As for Malaysia, most economists are expecting Bank Negara to resume its rate hike journey after the January pause, which is rather similar to what the Norwegian counterpart is expected to do as it awaits the impact of the 100-bps hike made in 2022 that has lifted the OPR to 2.75%.

Despite the stronger-than-expected fourth-quarter gross domestic product growth of 7% y-o-y, which took the whole year growth to 8.7% y-o-y and the fastest in more than 20 years, the outlook for 2023 is less sanguine, with growth likely targeted at between 4% and 5% this year, while consensus expects growth to slow to just 4.2% based on the median forecast.

Inflation too is expected to slow as the December 2022 print of 129.2 points was only higher by just 1.4% when measured against the June 2022 reading of 127.4 points.

Hence, as the index level is at a higher elevation, y-o-y growth will slow down in the later part of this year, allowing both the headline consumer price index and core inflation to moderate and drop considerably.

Given the above view, the OPR is unlikely to be raised in March or following meetings, contrary to market expectations.

IMF sees a better 2023

Based on the International Monetary Fund’s (IMF) “World Economic Outlook” report released in late January, the world body is now more optimistic than before, raising both its 2022 and 2023 economic outlook forecast by 0.2 percentage points each to 3.4% and 2.9% from its October 2022 forecast of 3.2% and 2.7%.

This is in vast contrast to the World Bank’s estimate in its “Global Economic Prospects” report published in early January when it slashed the 2023 outlook to just 1.7% from the 3% forecast six months prior, although it left the 2022 outlook unchanged at 2.9%.

For the IMF, the optimism is driven by China’s reopening post Covid-19 lockdown measures while inflationary pressure too has eased globally.

However, the World Bank’s less rosy outlook is on the premise of the impact of unprecedented policy tightening measures aimed at tackling very high inflation, worsening financial conditions, and the war in Ukraine.

The contrasting view by both the IMF and World Bank, with two reports released just less than a month apart, basically highlights the conundrum facing investors in 2023.

Markets are forward-looking

While the Dow Jones Industrial Average is up 1.7% year-to-date, the strong gains in the S&P 500 and Nasdaq, which are up by 6.5% and 13.3% since the start of the year, suggest its “risk-on” for investors.

This is despite the recent selling pressure on stocks on the back of inflation worries, requiring the Fed to hold a higher FFR for a longer time.

Elsewhere, the European markets are higher by 13.3%, while the Asian bourses, other than the FBM KLCI’s and Bangkok’s SET’s 0.8% and 0.6% drop, respectively, are firmer by between 0.7% and as much as 10.7% year-to-date.

Even highly risky cryptos, which had a horrible year in 2022, are firmer, led by a 43% gain in bitcoin’s price to more than US$23,730 (RM105,147) per coin, at the time of writing.

Hence, despite the economic data points that may continue to show weakness, markets are pricing in economic recovery and a milder inflation environment with key benchmark rates either at their peak or near the pivot point.

For the local bourse, being a laggard year-to-date, the market is seen as ripe for the picking.

Since the start of the year, the main gainers have been the consumer sector, selected construction companies, the tech sector, and some key FBM KLCI index-linked stocks, led by gains in Genting, Press Metal, QL Resources, Digi.Com and Maxis. Market laggards have been the banking sector, led by stocks like CIMB and AMMB Holdings.

This is perhaps a reflection of the pain points ahead due to Bank Negara’s move to leave the interest rate unchanged, which may lead to net interest margin compression as a result of front-loading fixed deposit rates by financial institutions ahead of last month’s MPC meeting.

Other laggards include MR DIY, Sime Plantation and IHH Healthcare.

With central banks balancing their narrative between turning dovish or maintaining a hawkish stance, markets have already priced-in expectations that inflation has peaked and will decelerate in 2023.

With that, a risk-on strategy is an appropriate one.

Pankaj C Kumar is a long-time investment analyst. The views expressed here are the writer’s own.