Two, not three, US Fed interest rate hikes expected in 2019: analysts

Singapore

ANALYSTS expect the United States Federal Reserve to hike interest rates twice instead of thrice this year, with the Fed Funds rate forecast at 3 per cent.

In their Global Outlook 2019, OCBC analysts said that "a gradual rate hike trajectory remains intact", citing the US's strong quarter-on-quarter annualised gross domestic product (GDP) growth of 3.4 per cent in the third quarter; unemployment holding at a low 3.7 per cent with few signs of wage inflation; and core personal consumption expenditure inflation edging towards but remaining short of the 2 per cent target.

However, recent market volatility combined with the flatness of the yield curve "may give the Fed room for a pause", they added.

They noted the December Federal Open Market Committee (FOMC) statement's addition of the word "some" to the phrase "further gradual increases", suggesting a limited number of remaining rate hikes.

They see two rate hikes being likely in 2019, but stressed that the situation is data-dependent. If wage inflation accelerates amid still resilient growth, "there is little to stop the FOMC from doing a third hike if the data warrants it", they concluded.

Economic performance should be able to sustain US dollar strength into the start of 2019, but as the year goes on, "the weakening fundamentals should make broad USD prospects considerably murkier", they said.

OCBC sees the Fed's hiking cycle entering its last legs by mid-2019, giving the other major central banks the opportunity to catch up to the Fed in terms of policy normalisation.

UOB head of markets strategy Heng Koon How and rates strategist Victor Yong also expect two rather than three hikes in 2019, seeing this as a likely inflection point in the prevailing monetary policy tightening cycle for both US and Singapore.

With investors' sentiments coloured by growth fears and risk aversion, as of the final week of December, there was barely one Fed hike priced in for the whole of 2019, they noted.

"Should US growth momentum deteriorate at a quicker pace than we currently expect, that would validate market-based rates pricing and result in further downside revision to our own forecasts."

But as it stands, they expect US inflation and employment in 2019 to remain consistent with the Feb funds rate converging onto its neutral rate of around 3 per cent.

The UOB analysts see both the three-month US London interbank offered rate (Libor) and 10-year US Treasury (UST) yield rate rising to 3.25 per cent by the end of 2019.

"The 10-year SGS (Singapore Government Securities) yield is expected to continue to mirror the gyrations in 10-year UST yield, but will eventually recover to 2.6 per cent by end 2019," they said.

The UOB analysts also see both the three-month Singapore interbank offered rate (Sibor) and three-month swap offer rate as drifting higher towards 2.45 per cent by the end of the year.

OCBC's 2019 forecast for the three-month Sibor is 2.33 per cent. In its report, OCBC also noted the potential for Asian monetary policy divergence in the year ahead.

In contrast to 2018's convergence in monetary policy normalisation, 2019's external environment "looks to be one of further moderation in momentum, coupled with likely exacerbated market volatility, which may drive a wedge further into the convergence of monetary policy trajectories," the analysts said.

They expect that "the story may start to diverge more clearly from 2019 onwards, especially if a significant correction occurs in a major economy like the US".