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So, the Fed is finally afraid huh? What a change of events. In 2022 and 2023, the talk was always ‘Inflation is out of control. We must bring it back down. The economy? It’s doing fine.’ But I have always written that the Fed is more concerned about the strength of the U.S. economy rather than inflation.

If you don’t know, the Federal Reserve has two objectives. To drive the economy moving forward, and keep inflation under control. Central banks sort of use this rule called the Taylor rule to guide their monetary policy. If the economic growth is low, they try to stimulate growth by lowering interest rates. However, if they do this, inflation will increase. So, if inflation is too high, they increase interest rates to bring it back down. It’s a fine balancing act.

However, in recent months, the conversation has gone to ‘Hey, we want to decrease interest rates’. I have an idea why. Investors are expecting a recession by May 2024 – as high as 70%. As much as we think the Fed cares about inflation, it cares more about growth.

And that has implications for the Ringgit. You see, the Ringgit has been under relentless selling pressure in the last year due to the high U.S. interest rates. The intuition here is simple. Typically, interest rates or government bond yields in Malaysia are higher than in the U.S. Because of this, investors prefer to buy Malaysian bonds and Ringgit.

However, that reversed when the U.S. increased its interest rates. The trend reversed and U.S. government bond yields are now higher than Malaysia’s one. Hence, more money flowed to the U.S. and not Malaysia. The Ringgit is sold in this case then.

In a recent article, I wrote on the Ringgit projections. I used a simple model to try to project the Ringgit in the coming months. However, it is simple. I have since made more improvements to it by adding three variables (money supply, Brent crude oil prices, and terms of trade). I obtained the ideas of these variables from the works of these academicians.

1. Brent Crude Oil Prices: Shamaila Butt, Muhammad Ramzan, Wing-Keung Wong, Muhammad Ali Chohan, Suresh Ramakrishnan (2023)
2. Terms of Trade: Bashir and Luqman (2014)
3. Money Supply: Quadry, Mohamad, Yusof (2017)

Here are the specifications of the model in simple terms. The Ringgit is projected with variables of Malaysia’s 1Y bond yield minus the U.S. 1Y bond yield, money supply (M3 growth), Brent crude oil prices, and terms of trade (export value/import value). The model is ok with a R fit of 76%, which means about 76% of the Ringgit movement is explained by these variables. It’s not perfect, but it will do.

Here are several assumptions and projections that I have put in here to project.

1. Interest rates in the U.S. will be decreased by 75 basis points.
2. Brent Crude Oil price will be US$87 for 2024.
3. Terms of Trade at a historical average of 110 for 2024.

The Ringgit is expected to trade at RM4.69 in June 2024, strengthen to RM4.53 in September 2024, and finally trade at RM4.50 in December 2024. A couple of explanations are in order here. Firstly, the Ringgit is still expected to be weak in June 2024 because of an expected recession in the U.S. When that happens, many investors will buy the safest asset in the world – U.S. government bonds. Hence, the Ringgit will be sold.

Secondly, the Federal Reserve is expected to reduce interest rates by 75 basis points in the second half of 2024. This means that Malaysian government bonds will be relatively more attractive to hold compared to U.S. government bonds. This will help strengthen the Ringgit. How will this help you? First of all, if you are planning to go on a holiday like me, it might be better to hold off until the end of the year when the Ringgit is in better shape. If you are an investor and hold U.S. investments, now until June 2023 might be a good time to look for an opportunity to exit your investments.