For most part of this year, the Federal Reserve officials have repeatedly pledged to remain firmly committed to take inflation down to the medium-term target of 2%.
Maybank Research said today (May 29) that while more officials have started to become cautious of the accumulative effect of the aggressive rate hikes undertaken thus far, all officials refrained from signalling an outright monetary policy pivot (to rate cuts).
Maybank said their most conservative projection for U.S. inflation suggests headline CPI could land around 3% by the end of the year, above the 2% target. However, a look into history suggests that Fed is still more sensitive to labour market deterioration rather than inflation.
As such, rate cuts in 2H 2023 are still a possibility.
Not All Rate Cuts Bring USD Weakness
Maybank, upon investigating the rate cut cycles since the turn of the century for the impact of rate cuts, found that not all rate easing cycle bring about significant USD weakness. USD strengthened substantially in 2001 as the US economic cycle seems to have troughed already by the first cut and started to rebound ahead of the rest of the world.
In 2007, the USD weakened more as other central banks continued to tighten after Fed cuts. That could hint of mild USD weakness for 2H 2023 should ECB and BoE continue to hike after Fed pauses/cuts.
When Fed eased in 2019, global growth slowed gradually along with the US. USD saw mild weakness.
In this cycle, Maybank’s base case assumes growth to slow gradually, potentially cushioned a tad by a delayed China recovery. USD could thus weaken.
Their second major finding, SGD, MYR, THB, IDR have performed well after Fed started easing in 2007 and 2019.
Third, Gold strengthened when the Fed cuts, yields fall and USD weaken. So, gold could still remain a preferred play. In a black swan event, gold could also continue to outperform. So, the environment in a late cycle continues to favour gold, especially as tightened credit conditions result in stresses in the financial markets that could erupt into crises.
Maybank has developed a market sentiment index to monitor signs of market stresses. The exception is if the U.S. economy were to rebound faster than expected and ahead of the RoW, the USD strength would negate the boost that the decline in the real yield brings to gold.
U.S. Debt Ceiling and Default – A Risk We Cannot Ignore
Maybank hasassigned a 60% probability of the debt ceiling to be raised and default avoided and make this our base case given that we think neither the Republicans or Democrats would want to risk being blamed for the ensuring fallout that can come from a default. X-date has just been revised to 5 Jun and we anticipate that it could fall anytime between Jun-Oct.
However, the longer the government stays afloat without a deal, the higher the volatility is likely to be for markets due to a rising uncertainty. In the event there is a default, the DXY has historically shown to be more subdued.
This time around, it is difficult to say that necessarily DXY strength would come off because market focus may be towards the Fed rate path. If the debt ceiling is raised and default avoided (even whether a deal is done at the eleventh hour), sentiment may improve and the risk sensitive currencies including the MYR, THB, PHP and IDR may get a lift. SGD may also see some strengthening.
