Michael Lai, Vice President Wealth Management Research, OCBC Bank, Member of OCBC Wealth Panel

Central banks across the developed markets (with the exception of the Bank of Japan) are starting to sing the same tune – it’s time to start tightening interest rates and stop pumping money into the economy. The more attractive (..and safer) return prospects in the developed markets (DM) have triggered capital flight out of the emerging markets.

As money flows to developed markets, some emerging market central banks have begun hiking interest rates out of cycle in order to prop up their weakening currencies, get ahead of inorganic inflationary pressures and to try retaining investors’ interest.

source: CNBC

Closer to home, Bank Negara Malaysia (BNM) has hiked interest rates in January to 3.25%. Policy makers took the strengthening economy and overall stability in the country as signal to begin normalizing easy monetary policy to a certain degree. The MYR was at 3.88 to a dollar and economic prospects were solid.
However, much has happened since January and in tomorrow’s meeting many investors are questioning how policymakers will move on interest rates.

There are some fears that the central bank may cut interest rates in response to the new Pakatan Harapan government’s policies, which includes tighter fiscal conditions and overall scrutiny over infrastructure projects – sparking concerns of a weaker growth prospects in Malaysia.

• These fears are further fuelled by the deteriorating ringgit, which now stands at 4.01 to a dollar, as investors shift funds to the developed markets on prospect of higher interest rates and rising uncertainty in Malaysia due to change in government in the 14th General Elections.
• We think this worry may be misplaced. While there may be compelling reasons for a potential cut, especially to spur economic activity at a time when the government is pulling back on spending, the underlying economy is still healthy. Inflation has been slow to pick up and the abolishment of GST lessens the pressure on consumers’ pockets.

At this point, we expect BNM to stand pat on interest rates and not rush to move on policy. Policymakers are likely to stay on the side-lines, observing the impact of PH Gov. policies on the economy as well as the continued tightening in DM. A rate hike may be in the works sometime next year – but much of it depends on Malaysia performance for the rest of this year.

The noise in markets presents us a number of opportunities;

• Take advantage of the weakness in emerging markets by buying low and selling high. In order to minimize losses, consider the stabilizer approach. We think that the current weakness is just due to temporary selling in the market despite solid fundamentals. Buy gaining exposure now, you can benefit from rising asset prices when the market recovers.
• Prop up your portfolio with dividend/coupon paying assets. Markets are plagued with uncertainty, especially stemming from the anti-trade US policies and geopolitical tensions. While rising interest rates may diminish return prospects slightly, dividend and bonds fund return consistency will continue to provide sufficient buffers to an investor’s portfolio.
• Diversify. While we may seem domestically bias, there are still plenty of opportunities in Malaysia. A rate cut may be too premature and we don’t believe our policy makers to act so brashly. With the world watching the country, policy makers will tread lightly so not to cause panic. Rates aside, economic performance is solid and we expect to end the year with a strong 5.5% GDP growth (only slightly lower than 2017’s 5.9%). However, we realize the importance of diversification and suggest that you consider global diversification strategies in order to avoid any unforeseen pitfalls in the markets by reducing concentration risk.