US
The rally in crude oil prices lost traction, USD is trading on the defensive against most major currencies, while both stocks and bonds bounce. Markets are treating renewed US-Iran strikes as another round of managed escalation and that the global economy can continue to absorb the geopolitical shock. Indeed, the IMF July World Economic Outlook Update noted that “the global economy as a whole has, so far, weathered the shock from the war better than feared.”
Fed funds futures hardly budged after the release of the FOMC June 16-17 meeting minutes. Fed funds futures continue to fully price-in one 25bps hike to 3.75%-4.00% in October and small odds of a follow up increase in December. The minutes shed more light on the hawkish hold with four key takeaways:
(i) Inflation was the dominant concern. “The majority of participants highlighted the possibility that, after several years of inflation above 2 percent, continued elevated inflation rates could begin to affect inflation expectations and wage- and price setting decisions.”
(ii) The labor market outlook discussion was encouraging. “Several participants noted that the solid payroll employment data in recent months could signal increased labor market momentum.”
(iii) The policy outlook debate reflected the hawkish shift in the dot plot. By year-end, “many participants” saw the funds rate “within or slightly below the current target range at the end of this year”, while “many other participants” saw the funds rate “above the current target range.” In parallel, “A few participants commented that…there was a case for raising the target range for the federal funds rate [in June].” As a background, 9 of 18 officials penciled in at least one rate increase by year end versus a median projection of one cut in March.
(iv) There was a broad degree of unity within the Committee. “Most” participants backed removing the easing bias from the statement and “a majority of participants saw advantages in shortening the statement.”
Second-tier US data today are unlikely to move USD or rates. Going forward, we expect the dollar index (DXY) to edge higher. US-G6 two-year bond yields are consistent with DXY trading closer to 102.00 and US economic outperformance should keep rate differentials supportive of the dollar.
EUROZONE
EUR/USD rose briefly to an intra-day high near 1.1450 before paring back gains. The ECB will publish the Account of the June 11 rate decision today (12:30pm London, 7:30am New York). At that meeting, the ECB unanimously voted to raise the policy rate by 25bps to 2.25% because of rising inflation pressures. The debate over the expected slowdown in the Eurozone economy will be closely watched, as it could shape the ECB’s appetite for further tightening.
The swaps curve price in the next 25bps hike at the September 10 meeting. We think the ECB can afford to be patient before tightening again. Cooling Eurozone wage growth and subdued demand conditions should help contain inflation pressure. Bottom line: EUR/USD will likely trade closer to 1.1400 in the next few months, with the risk skewed to the downside.
MALAYSIA
USD/MYR traded sideways within its recent range around 4.8000. As was widely expected, Bank Negara Malaysia (BNM) left the policy rate on hold at 2.75% for a sixth consecutive meeting. BNM also maintained its neutral bias, highlighting it “considers the monetary policy stance to be appropriate and consistent with the outlook of continued price stability and sustainable economic growth.”
Bottom line: Malaysia’s positive real rate remains supportive of MYR, but the ringgit’s elevated valuation is a major headwind. MYR is 13% overvalued relative to its real effective exchange rate trend, the most since 1997.
