Global Economics & Market Strategy

Economics Weekly View: US FOMC’s QT Taper is Likely Inflationary

03 May 2024
 

Barnabas Gan Acting Group Chief Economist & Head, Market Research

• We look for further global inflationary pressures in 2H24, whereby upside in price pressures will likely be exacerbated by the US FOMC’s decision to shrink its balance sheet at a slower pace starting in June. The shrinking, also known as Quantitative Tightening (QT) Taper, will reduce the monthly cap on Treasuries to mature without being reinvested to US$25 billion (from US$60 billion) while keeping the cap on mortgage-backed securities unchanged at US$35 billion. We see three key observations: (1) the lower amount of Fed Treasury holdings to mature may cushion the negative growth impact on the US money supply, (2) whereby the US M2 money supply leads US core CPI by around 18 months (See Figures 39 and 40), and (3) the decision to taper the QT may be viewed to be less restrictive on policy by allowing more maturing USTs to be invested. 
   
• We keep our forecast for one FFR cut by December 2024 to 5.0 – 5.25%, with the risks for no rate cuts increasingly magnified at this juncture. With the US FOMC opting for a less restrictive open market operation (OMO) approach, as aforementioned, we see little risk of a counter-productive rate hike decision this year. US March’s core PCE inflation persisted at 0.3% MoM, thus reinforcing our forecast for year-end print to surpass its 3.0% handle. Suffice it to say, US prices are not on the path towards 2.0% in 2024, and ongoing US labour market strength (note tonight’s nonfarm payrolls) will further persuade market pricing out effects of FFR cuts towards end-year and 2025 instead. The current market pricing of the first FFR cut is on November 2024, which will likely be adjusted towards December in the coming weeks. 
   
• The caveat to an earlier-than-expected rate cut must be met with several essential conditions. First, with inflation being the fundamental argument here, FFR cuts may materialise should overall US inflation slow materially to around 0.0 – 0.1% MoM (the case will be strengthened if MoM turns negative). Second, even if inflation stays elevated, a sudden deterioration of US labour conditions and potential global recessionary cues could persuade the Fed to pursue maximum employment instead of price stability. Third, from an exogenous perspective, protracted geopolitical tensions (see our thematic report) that may derail the current global economic growth trend may also give reason for accommodative policies.
   
• Fundamentally, we continue to like the DXY, albeit we recognise technical indicators that may inject interim weakness. The continued pricing out of FFR cuts (or should market voices centring on rate hikes intensify) will continue to support the DXY. In the following weeks, the downside in RSI at neutral levels, with MACD extending its bearish divergence, could persuade short-term profit-taking until indicators signal otherwise. We think fundamentals will eventually prevail, with the DXY approaching 110 in 2Q24 while the UST 10YR yields a trend towards 5.0% in the same period. 
   
• Next week’s key data include Malaysia’s BNM meeting, whereby we expect policymakers to leave its benchmark rate unchanged at 3.0%. We are also closely eyeing Indonesia’s 1Q24 GDP print, where we are pencilling 5.07% YoY (-0.87% QoQ). Separately, we published a thematic report on the IDR, whereby we expect USD/IDR to remain elevated above 16,000 throughout 2024, reaching its peak in 2Q24 before stabilising on a flat trajectory towards the year-end. 
   

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