THE United States’ inflation hitting a 40-year high at 7.5% has raised concerns, among other things, aggressive interest rate hikes in the US and the ensuing capital outflows from the emerging markets (EMs).

       If that happens, Malaysia too will not be spared as narrowing interest rate differentials spur capital to flow back into US markets to take advantage of the higher rates there.

       As a result, there may be volatile capital swings while the US and ringgit exchange rate may also be impacted.

       The spotlight will be on the US Federal Reserve (Fed) and how they control this rising inflation, which is expected to ease over time as higher US rates lead to lower private consumption.

       Many people may not realise it but a bust may follow if the Fed turns as resolute as previous Fed chairman Paul Volcker (1979-1987) was in combating inflation.

       (To fight inflation, Volcker had raised the federal funds rate to 20% in 1981, which had helped lead to the recession of 1980 to 1982).

       Policy error is a risk now.

       As the Fed plays catch-up and hikes rates (after being behind the curve for the past one year), it raises the risk of policy error.

       “We have highlighted over-exuberant US monetary policy tightening as a key market risk for some time now,’’ said RHB Investment Bank head of regional equity research, Alexander Chia.

       More US rate hikes are on the cards, from earlier expectations of three increases.

       Volatile capital swings in EMs will occur as investors reprice and rebalance their portfolios on the expected impact of higher US rates and bond yields on the economy and earnings.

       “A substantial narrowing of the rate differential between Malaysia and the US will exert downward pressure on capital flows in Malaysia and the US and ringgit exchange rate,’’ said Socio Economic Research Center executive director Lee Heng Guie.

       As the dollar rises in value in anticipation of higher US rates, the ringgit could depreciate, which results in a higher import bill.

       However, exports will become cheaper to foreign buyers.

       With hawkish comments from some US officials on possible US rate hikes, futures are pricing in a higher probability of a double-loaded 50 basis points increase in March.

       However, the dollar has not strengthened that much, so far, partly as other major central banks like the European Central Bank and Bank of England, have also turned more hawkish.

       “This has helped put a lid on overt volatility for EMs, overall. Increasingly, there might be a need for central banks in EMs to start hiking rates more proactively to counter such outflow risks,’’ said OCBC Bank Malaysia Bhd economist Wellian Wiranto.

       Some do not think the situation is that alarming.

       There are some inflation components that are specific to the US and EM inflation baskets could monitor very different items.

       As such, the impact is more muted, nevertheless, it is definitely higher than what has been experienced in the past two years.

       “The biggest impact has already played out in the bond markets through higher yields and foreign exchange markets from dollar strength; we expect the moves to be nearly done,’’ said Hong Leong Bank Bhd managing director, global markets, Hor Kwok Wai.

       In terms of foreign exchange, in particular EMs, could benefit from the opening up of travel and stronger growth as the Omicron variant numbers ebb in line with what is seen in the US and Britain.

       There is a silver lining too, as companies may try to reduce costs by moving their production to EMs. Being suppliers of cheaper goods and commodities, many EMs may benefit in a relative sense; consumers trade down and EM producers of commodities collect higher returns from their produce.

       “Some companies may even double down on trying to reduce costs further by moving an even higher percentage of production to EMs,’’ said former Inter-Pacific Securities head of research Pong Teng Siew.

       As rates rise strongly in the US, inflation may ease in the coming months as higher rates lead to lower private consumption in the US and Europe.

       “Inflation may remain high for the next quarter but should ease in the second quarter,’’ said Etiqa Insurance & Takaful Bhd chief strategy officer Chris Eng.

       Commodity prices should also ease, added Eng, unless Russia does invade Ukraine, which is uncertain.

       Following the Beijing Winter Olympics, industries should also restart in northern China and together with opening up of restrictions worldwide, help ease some supply bottlenecks.

       Locally, the tight supply of foreign labour may eventually ease, allowing greater harvesting of oil palm, possibly towards the end of the second quarter, said Eng.

       In terms of the impact on equity markets, stocks or sectors that have been trading at exorbitant valuations, and are not supported by existing business fundamentals, will be most affected.

       “But Asian markets have been trading at fairly moderate valuations, so there are less concerns over the impact on stock prices,’’ said Fortress Capital Asset Management Sdn Bhd CEO Thomas Yong.

       A word of caution is that there could be an adverse impact on growth if EM countries hike rates just to preserve interest rate differentials with the US, and not consider local dynamics.

       But for now, that scenario is not likely, as currencies in Asia are stable and many central banks have indicated that the local growth trajectory remains their key policy determinant, said Hor.

       Moreover, China is on an opposite stance to the US, and is loosening monetary policy. In the long term, we are in a new growth cycle as globalization and adoption of new technologies will help, in due course, to alleviate inflationary pressures, said Chia.

       Taking into account the long term views and short term concerns, we may be about to enter a challenging period of balancing growth with rate hikes.

       Yap Leng Kuen is a former StarBiz editor. The views expressed here are the writer’s own.