Malaysia and the world await US interest rates lift-off

PETALING JAYA - The one event that has dominated the theme for this year is the first interest rate hike in the US since 2006.

Everything points to the Federal Open Market Committee (FOMC) deciding for the lift-off in interest rates in the US, which has remained between 0 per cent and 0.25 per cent since the global financial crisis in 2008.

The increase is likely to be 25 basis points (bps), and this has caused equity markets around the world to trend downwards.

Apart from equity markets, there are also fears that banks would face increasing pressure on their asset quality on the back of higher cost of funds.

Traders are expected to look for clues on the Federal Reserve's message on its next rate hike, should the rates take off tomorrow. Previously, Fed chairman Janet Yellen has said that further hikes would be gradual.

Affin Hwang Capital Research believes the Fed would be diligent in managing market expectation on the pace of subsequent rate hikes.

"After the likely 25 bps rate hike in December's FOMC meeting, we expect three 25 bps hikes possibly one each in April, September and December next year," the research house said.

As far as the Fed watchers are concerned, many economists have projected the Fed to "formalise" the subsequent rate hikes, whereby rates would end up no longer being below "normal" levels.

OCBC Bank expects four to five interest rate hikes next year instead, with it highly likely lifting off this month, due to positive data from the US.

"In that respect we are not talking about sharp increases, but 25 bps four to five times. But it depends on how data in the US play out. One of the key things is the employment market," said OCBC vice-president of wealth management for Singapore Vasu Menon in a recent interview.

The Fed expects the economy to trend higher at 2 per cent-2.3 per cent in 2015, from its earlier projection of between 1.8 per cent and 2 per cent, and expand by 2.2 per cent-2.6 per cent in 2016 as household spending is advancing and the housing sector has shown improvement.

Vasu said that a rate hike would negatively impact Asian markets in the near term, but not as significantly since some of the sell-off had been front loaded earlier this year.

The impending rate hike has been the theme that has dominated all asset classes, from equities to commodities and currencies. The equities market has been on a gradual decline.

The commodities market has taken a hit from the collapse in oil prices and also the slowdown in China while emerging market currencies have depreciated by more than 25 per cent against the US dollar in the face of capital outflows back to US markets.

The ringgit has dropped more than 20 per cent this year to 4.3012 against the greenback, while the FBM KLCI has fallen 7.86 per cent year to date, closing at 1,622.84 points yesterday. Brent crude after hitting a high of US$115 per barrel in July last year is now down to US$42 per barrel.

Bank Negara will face tough choices following the FOMC's decision. It last raised interest rates by 25 bps to 3.25 per cent in July last year.

Kenanga Research said it expected the central bank to have an increasingly tougher choice of either putting more effort to stanch the outflow of capital to defend the ringgit or supporting the waning economic growth.

"If the choice is to defend the ringgit by raising rates, economic growth would suffer. If it were to cut rates to support growth, the already weak currency would further depreciate," it said.

It added that it would be safer to assume that Bank Negara would hold on to its standard policy of maintaining "growth and financial stability".

"Based on historical trends, it had only cut rates three times out of the eleven rate adjustments (the remaining eight were rate hikes) made since the Monetary Policy Committee was established in May 2004. And all the three cuts were made in the span of less than three months between Nov 24, 2008 and Feb 24, 2009 at the height of the Global Financial Crisis.

"But that shouldn't be the rule of thumb for Bank Negara's rate decision," said Kenanga.

Therefore it does not discount the possibility of the central bank sharpening its knife again and cutting interest rates even though the slowdown of global and domestic economies is not as severe as in 2008.

If the central bank does decide to cut interest rates, it has a small window to do so, and this would depend on how economic growth pans out in the next three to six months, according to Kenanga.