This article first appeared in The Edge Malaysia Weekly on November 29, 2021 - December 5, 2021

THE reappointment of Jerome Powell as US Federal Reserve chairman for a second term came as a relief to the market for a number of reasons. Chiefly, it offers some predictability as well as continuity in the Fed leadership as it prepares to hike rates and reduce the pace of its asset purchase programme.

Nevertheless, with inflation fast rising in the US, many are starting to wonder if the Fed will step up its tightening policy in an effort to tame inflation. Currency experts warn that in the event that US rates begin to creep up, the already weak ringgit can be expected to be punished further.

In a note by UOB Global Economics and Market Research, the bank highlighted that a key takeaway from the recent Federal Open Market Committee (FOMC) minutes, released on Nov 25, is that an increasing number of Fed officials are willing to accelerate the asset purchase programme tapering and to consider an earlier rates lift-off, if inflation remains persistently high.

Most experts concur that the Fed is likely to move more quickly to hike rates and accelerate tapering.

“This is a distinct possibility. Recent comments by Fed officials have signalled that there is a chance of an increased pace of tapering. This could then follow through as an earlier policy rate lift-off when tapering ends earlier than the current mid-2022 baseline. We expect the Fed to catch up to elevated rate hike expectations as we head into 2022,” comments OCBC Bank FX strategist Terence Wu.

Even so, there are different views as to the timing and pace of lift-off, with the general consensus indicating a hike in June 2022.

UOB agrees with the consensus view, as it anticipates that the tapering completion timeline will be brought forward to April 2022, and that three rate hikes will be instituted next year.

“Our projection for the first federal funds target rate hike will be in June 2022 by 25 basis points to between 0.25% and 0.5%, followed by two more hikes in September and December 2022. We are also projecting two more 25bps rate hikes in 2023 in 1Q and 3Q,” it said.

Jeffrey Hally, a senior market analyst for Asia-Pacific at OANDA, sees the hikes taking place in the later part of the year, however, in September at the earliest. “There is a strong case for an acceleration of Fed tapering, but I believe the market is getting ahead of itself in pricing in a tightening in June 2022.”

Divya Devesh, Standard Chartered head of Asean and South Asia FX research, also believes the market’s projections to be too aggressive. Instead, he forecasts the Fed’s initial policy rate hike will take place in 3Q2022, followed by two more hikes in 2023 and one in 2024.

“We expect the Fed to emphasise the fact that the US economy is approaching inflation and maximum employment targets, rather than expressing concern about elevated inflation. The message likely will be a gradual pace of further rate hikes rather than an abrupt move,” he opines.

Divya adds that the three assumptions driving Standard Chartered’s view are maximum employment being reached in 2H2022, the easing of supply bottlenecks, and global availability of effective Covid-19 vaccinations and treatments.

“There is likely to be much less uncertainty about supply to complicate the policy-making calculus,” he observes.

The differing views on the timing of hikes and the number that the Fed will embark on in the near future aside, experts agree that the ringgit will have to brace for volatility in the coming months as the Fed moves towards normalisation of rates.

OCBC’s Wu says his current Fed baseline scenario suggests further gains for the broad US dollar, which will eventually flow through to the sheltered USD/Asia space.

He sees the USD/RM likely to come under greater upside pressure, alongside other USD/Asia peers. On the flipside, he adds, the resilient renminbi will help keep a lid on excessive USD/Asia and USD/RM gains.

“We cannot rule out a retest of the 4.2500 highs in the USD/RM, but we expect gains to taper off near those levels. We are not looking for excessive USD/RM gains towards 4.3000 or 4.4000 at this juncture,” Wu explains.

In the last month, the ringgit has depreciated rapidly against the US dollar as the greenback gained strength. At the time of writing, the ringgit stood at 4.2420 against the US dollar. Two months ago, on Oct 26, the ringgit was at 4.14.

OANDA’s Halley believes the ringgit, like most Asian currencies, will face downward pressure through December and well into 1Q2022 when the reality of the Fed tapering starts to bite and, with that, ultra-low policy rates draw to an end.

“Asian economies are out of sync with the US, with every central bank in the region — bar South Korea and Singapore — still setting monetary policies to support their economic recoveries.

“Given that policy tightening is off the table and most of Asia runs some sort of dirty peg to the US dollar, they can either burn through foreign currency reserves to support their currencies or they can choose to tolerate higher imported inflation via currency depreciation.

“My belief is that they will take the latter option, like India and the Philippines have over the past year and a half,” Halley says.

He sees the USD/RM likely to rise to 4.25 in the short term, with the cross returning to its 2020 highs of around 4.4500 in 1Q2022.

UOB economist Julia Goh warns that other factors that could affect the ringgit include a potential virus resurgence risk that has an impact on economic growth, resilience of the renminbi and oil prices in the coming months.

“We note that the recent strength in the RMB may be short-lived, given increasing risk of a China growth slowdown, and it will be hard to fight US dollar strength amid bullish expectations of the Fed.

“Thus, the ringgit may be susceptible to more volatility, particularly after the recent breakout above 4.20 against the US dollar,” she says.

Standard Chartered’s Divya, who believes the expectation of three Fed rate hikes in 2022 is aggressive, says the ringgit has weakened in recent weeks in response to the market bringing forward its rate hike expectations. He does not think, however, that the Fed will deliver on the current market pricing, which would allow the ringgit to recover.

“The ringgit fundamentals are still robust, driven largely by the sizeable trade and current account surpluses. This will provide sufficient buffers for the ringgit to withstand the headwinds from global monetary policy tightening. We forecast USD/RM at 4.10 by mid-2022,” he adds.

With the Fed expected to tighten its monetary policy in the near future, Bank Negara Malaysia should not be too far behind.

Divya expects Bank Negara to start its hiking cycle in 3Q2022, following the Fed’s tightening.

Similarly, Goh also believes the rate will stay where it is currently until 3Q2022, when she expects it to increase by 25bps to 2%. She says potential triggers for an earlier rate hike would be a more robust and stable domestic growth in the months ahead, and signs of a wider pass-through of higher costs to consumers as the economy recovers.

“For now, the central bank says it is ‘mindful of a premature withdrawal of policy support’ even as recent indicators suggested a more positive momentum going forward, and global central banks are mulling policy normalisation.

“This infers that Bank Negara may be patient on interest rate moves in the months ahead.”

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