Will the Malaysian market be impacted by US inflation worries?

• Feb 26, 2018

WITH US 10-year Treasury bond yields closing in on 3%, all eyes are on equities markets as bonds become more appealing as an asset class.

“The issues are inflation and rise in global yields. Bursa valuations will eventually be impacted,” said Vincent Khoo, head of research, UOB Kay Hian.

“Inflation worries on the back of strong US economic growth, rising wages and strong jobs data have caused the 10-year Treasury yields to inch higher, nearing to 3%, making bonds more attractive compared with equities.

“It is the very economic vigour that causes investors to anticipate higher inflation and interest rates. Investors will be closely watching key economic data and guidance from the US Fed.

“Every piece of good economic news is likely to raise concern on the prospect of higher rates, causing volatility as seen in recent market routs,” said Lee Heng Guie, executive director, Socio Economic Research Centre.

Last Wednesday, the benchmark 10-year note had risen to a four-year high of 2.957%; by Friday, it was 2.871%, from 2.917% late Thursday.

“If this is the early part of a general retreat on Wall Street, there will be arguments that commodities are well-positioned to ride out volatilities, with implications for commodity producing emerging economies.

“Inflation is expected to gradually edge higher, and rising commodity prices to play a key role. Bursa is well-placed as a stock exchange of a commodity producer nation,” said Pong Teng Siew, head of research, Inter-Pacific Securities.

But investors are reminded that in late 2007 and early 2008, high commodity prices propelled the main index higher even after the Dow had clearly commenced with a downturn.

“The US market is slowly pricing in a faster-than-expected rate hike by the Fed, judging by the solid pace of economic growth.

“Apart from a strong labour market, the US economy is supported by rising capital spending and possibly higher contribution from net trade following a weaker US dollar since 2016.

“From this perspective, a solid economic expansion is positive globally and its impact will likely trickle down to equity markets globally.

“However, a faster-than-expected pace in US rate hikes, if it happens, will likely cause a knee jerk reaction in financial markets,” said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.

Against US dollar weakness, export-led Asian markets are said to be able to cope well.

“Asian markets have been coping well with the Fed’s gradual normalisation of rates and shrinking of balance sheet, thanks to the weakening US dollar. This has defied expectations that the US dollar should strengthen from the Fed’s rate hikes.

“But Asian markets would have to brace for volatility in capital flows if US inflation rises faster than expected, compelling the Fed to raise rates more than expected.

“Raising rates at a time of rich asset valuation and compressed term premiums (the bonus for the added risk of owning longer term bonds) would likely cause a severe correction in markets.

“This will likely dampen global growth and confidence,” said Lee.

What if the pace of rate hikes does not overly surprise the market and the US dollar remains weak?

“Capital flows will favour Asian economies in 2018,” said Zahidi.

Fortunately, macro prospects for Asia remain relatively favourable.

“The global upswing in trade, partly induced by rising commodity prices, will ensure decent headline growth numbers for export dependent economies in 2018.

“Some Asian economies will also be supported by infrastructure investments, for example, Indonesia and Malaysia.

“A favourable domestic consumption story is also attracting investors,” said Zahidi.

Rising US bond yields are not expected to trigger another Asian financial crisis.

“Asian currencies do not face a bout of US dollar strengthening in spite of rising US Treasury bond yields, quite unlike the situation in 2013 (when the US dollar strengthened in anticipation of the ending of the Fed’s quantitative easing and then raising of rates).

“We are facing a set of unusual circumstances as the US is poised to step up its deficit spending spree with tax cuts, infrastructure spending and expanded military spending.

“This is at a time when business confidence is sky high and production indices are at very strong levels.

“All told, it is in a late expansion cycle stage when stepping up pump priming (the US government is increasing bond sales) seems to be out of place.

“The US government spending shortfall is even bigger than the budget outlay deficit which measures the deficit of outlay versus receipts; there are also pension deficits that will come in later.

“But the ‘future’ is arriving. For example, Calpers is about to require a big bailout soon that is not computed in yearly outlays,”

said Pong.

Columnist Yap Leng Kuen notes that we are entering uncertain times.

Source: https://www.thestar.com.my/business/business-news/2018/02/26/will-bursa-be-impacted-by-us-inflation-worries/#dfj1eZpH1bKiG11I.99