Fed’s dovish stance a positive for the market; signals US soft-landing

KUALA LUMPUR (Dec 15): As the US Federal Reserve held its benchmark lending rate steady for a third consecutive time during a monetary policy meeting on Wednesday, Fed chair Jerome Powell imparted global investors’ clarity on dovish pivot with a projection of three rate cuts to the Fed Funds Rate (FFR) in 2024 totalling 75 basis points (bps).

Domestically, the news rang sweetly in market watchers’ ears, as they envision the clear dovish policy to make emerging market (EM) assets attractive again in the coming year.

“Generally, equity responds positively to rate cuts on the premise that cheaper financing cost for business and lower deposit rates encourage spending. Given that rates cut in the US may also soften US dollar, it is generally positive on emerging equity markets as funds will look for a higher growth market,” Areca Capital Sdn Bhd CEO Danny Wong Teck Meng told The Edge on Dec 15.

“I am bullish on the domestic market,” he said, noting that downside risks to his position are whether the US economy would exit the Fed’s rate-hike cycle with a soft-landing, as well as other geopolitical risks.

Kenanga Research was more explicit in conveying its bullish view, saying in a note on Friday: “We expect the local market to lift off in a way likened to a rocket-propelled by three boosters in succession.”

Similar to Areca’s Wong, Kenanga’s view is premised on a “strong case” for investors to decisively return to EM equities with the Fed forecast to kick off its rate cuts as early as March 2024 based on the latest FFR futures, as well as assuming China’s economic and the conflict in the Middle East gradually stabilises.

The research house pegged an end-2024 FBM KLCI target of 1,605.

Rakuten Trade equity research vice president Thong Pak Leng also deemed the projected FFR cuts as a positive and expects the local market to perform better next year with an end-2024 KLCI forecast of 1590.

Despite the positive reactions from market watchers, the domestic bellwether KLCI ended just 0.43% higher at 1,462.45 on Friday.

Barring Singapore’s Strait Times and Vietnam’s Ho Chi Minh indices, all regional indices were in the green but with marginal gains compared to those seen on Wall Street.

Contrary to the bullish views, Vision Group managing director Chua Zhu Lian noted that rate cuts do not always translate to a stronger market, adding that economic conditions, corporate earnings as well as investor sentiment also have to be considered.

“We must consider the broader economic context, including inflation, which can impact the markets. What investors have to also pay attention to is whether there will be escalations to geopolitical conflicts, which can be a huge black swan event that significantly impacts stock market performance.

“On the domestic front, investors will also need to pay close attention to the political landscape and economic policies that the new government will roll out,” he said.

The Dow Jones Industrial Average and S&P 500 both rallied to fresh highs of 37,224.52 and 4,719.46 on Thursday. Based on the FFR futures, the market is taking an even more dovish stance than the Fed with a prediction of six rate cuts totalling 160bps in 2024 versus the monetary policy regulator’s three totalling 75bps.

While Malacca Securities head of research Loui Low Ley Yee also agreed that the Fed’s projected rate cuts will be good for global and local markets, he added that it will heavily depend on whether the US economy is headed for either a soft contraction of gross domestic product (GDP), then rebound; or hard landing — falls into a recession — and exit post-FFR upcycle.

“The Fed’s portray that the risk stance is good, they are expecting a potential soft-landing,” he said.

According to SPI Asset Management managing partner Stephen Innes, the projected rate cuts may not necessarily indicate that the Fed is inherently dovish; “but, instead, its stance is a response to the unexpected rapid decline in US inflation. The Fed is adjusting its approach in reaction to these economic dynamics.”

“[US Fed chair Jerome] Powell’s acknowledgment of the risks of keeping rates too high for an extended period could indicate concerns about potential vulnerabilities in specific sectors. The US housing market is the most egregious sector, as high mortgage rates have smothered the resale market and crushed the American dream unless you are making US$175,000 [RM817,264] per year,” he added.

Like Malacca Securities’ Low, the Fed’s rate cut projections reflect its current expectations of a soft-landing scenario, according to Sunway University Business School professor of economics Dr Yeah Kim Leng, whereby growth weakens and inflation tapers off in 2024.

The economist continued that a soft-landing of the US economy will be positive for the revival of Malaysia’s exports, as well as portfolio and foreign direct investment inflows.

“Consequently, the US dollar upcycle against most currencies will reverse thereby easing depreciation and imported inflation pressures for many countries, including Malaysia,” he added.

Both Rakuten’s Thong and Malacca Securities’s Low concurred with ringgit appreciation, but Low noted only a minimal consolidation to 4.50-4.60 against the greenback.

Speaking on the main concern of the soft-landing scenario, Yeah noted that a downturn in the US economy will hurt global demand as well as Malaysia’s exports, while heightened volatility in global financial markets dampens international trade and investment flows.

Bank Muamalat Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid concurred, noting that any slowdown in the US could transmit to Malaysia, saying Malaysia’s GDP is highly correlated with US GDP growth at 70%.

“Given that the BNM [Bank Negara Malaysia] has raised the OPR from 1.75% to 3.00%, they have the policy space to respond — they can cut the OPR should the situation warrant for such a response, depending on the severity of the US slowdown” he said.