IT was during March 2020 when the United States Federal Reserve (Fed) introduced the accommodative monetary policy of near-zero Fed funds rate.

       Later and later in June, the central bank introduced large scale asset purchases plan, or some economists may call it as quantitative easing (QE) with a whopping US$120bil (RM500bil) combination of Treasuries and mortgage-backed securities.

       This measure was to reverse the adverse effect of pandemic where the economy went into lockdown for months.

       Other major central banks similarly resorted to QE to spur the economic growth in their country after they pushed their key interest rates to record low as well.

       The European Central Bank (ECB) had pushed as much as €1.85 trillion (RM8.9 trillion) under its pandemic emergency purchase programme (PEPP), and Bank of England (BoE) has bought almost ￡900bil (RM5 trillion) of government bonds.

       Meanwhile, the People’s Bank of China (PBoC) lowered its interest rate and used other means to inject liquidity in the economy but refused to follow its peers in QE.

       On the local front, Bank Negara reduced its overnight policy rate (OPR) for a total of five time and lowered by a cumulative 125 basis point during the first half of 2020 to a record low of 1.75% to keep the economy going.

       A double-edged sword

       The unprecedented move by central banks to restart the economy severely affected by the Covid-19 pandemic and accompanied by fiscal and non-monetary measures plus the improving pace of vaccination helped to revive the global economy.

       Most of the rich economies registered double digit gross domestic product (GDP) growth during the second quarter of 2021.

       This includes Malaysia’s GDP which grew by 16.1% partly supported by the low base.

       Besides strong economic growth, headline inflation grew much stronger during the quarter. Malaysia’s average inflation in second quarter grew by 4.2% compared to first quarter reading of 0.5%.However, the global economy including Malaysia experienced some strong headwinds in the third quarter due to the Delta variant that resulted in the reimposition of lockdowns and the movement control order. Hence, expectations are for global economies, including Malaysia, to slowdown in the third quarter.

       But resulting from the restrictive measures, it has severely disrupted supply chains. It hampered growth activity and the stagflation dynamics were at play. However, this notion of stagflation is being downplayed as the expectations are for global inflation to moderate sometime in 2022 and global growth to remain elevated. Such a trend is also envisaged for Malaysia.

       Fourth quarter challenges

       As we approach the fourth quarter of 2021, most of the stagflation concerns have been priced in. This mean upside surprises to inflation would moderate and downside surprises of growth would ease.

       This is due to the better alignment of expectations with what is really happening compared to the view of moderating stagflation pressure. It is more likely to be in the US and Europe. Thus, the focus would shift to a fragile and transitory economy, moving away from a stagflation notion in the fourth quarter.

       On that note, the global monetary policy that shows the current environment, allows for a little more hawkish tone, relative to even just a couple of months ago, hence we expect central banks will adopt a more dovish stance heading into the year end, and early 2022.

       We believe there are many moving parts in the macro picture, and any number of unexpected developments could derail our thesis – which is fragile, and likely, transitory. Besides, the balance of risks remains firmly to the downside.

       There are three key downside risks that we should take note. They are potential monetary and fiscal policy mistakes; the Delta variant and stagflation or supply shocks; and China’s risk that can delay the effects of policy tightening that are likely to continue to weigh on growth.

       How will the monetary plan pan out?

       Due to the inflationary pressure seemingly more persistent than what they have initially thought, central bankers are mulling to depart from their current loose monetary arrangement to prevent the economy from overheating despite the labour market being still far away from the pre-pandemic level.

       The Fed took a shot at its bond purchasing programme during its recent meeting as it plans to start to taper later in November by US$15bil (RM62bil) land is expected to conclude around June 2022.

       But the Fed kept interest rate unchanged. We only foresee a rate hike in the second half of 2022, once the tapering has been concluded.

       And the divergence seems to be widening among other central banks. For instance, the ECB has pushed back against suggestions of a taper and hiking interest rate which is very unlikely to happen next year.

       The BoE retained its current interest rates level. It was the opposite of investors’ expectations who were expecting for a rate hike which would have made it the first among world’s major central banks to raise rates.

       Meanwhile, the PBoC has cut its reserve requirement ratio most recently in July and injected liquidity into the banking system to calm the market amidst property giant Evergrande’s crisis.

       The Chinese central bank also needs to keep its slowing economy buoyed through targeted measures and not make blanket-like moves especially since the Fed is starting to tighten its policy. Expectations are for another 50 basis points cut in 2021.

       Domestic progress

       Looking at the local side, the economic recovery progress is emerging but remains to be fragile. The most recent high-frequency data showed improving reading following the relaxation of the restrictive measures.

       Added with the stimulus measures, 12th Malaysia Plan, Budget 2022, firm commodity prices and exports, the expectations are of the economy to gain momentum considerably moving forward.

       With downside risk still remaining, we expect the OPR of 1.75% to stay until end of the first half of 2022.

       Any rate hike thesis is more likely to take place in second half of 2022 by about 25 basis points.

       For FX enquiries, please contact: ambank-fx-research@ambankgroup.com. For Fixed Income enquiries, please contact: bond-research@ambankgroup.com

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