KUALA LUMPUR (Aug 3): A further reduction in interest rate by the US Federal Reserve in the second half of the year (2H2019) will provide more room for Bank Negara Malaysia (BNM) to adjust the overnight policy rate (OPR) downward again, says Malaysian Rating Corp Bhd (MARC).

"Although our base case scenario calls for the OPR to remain at status quo for the rest of the year, we do not rule out the possibility of another downward adjustment in 2020 if macroeconomic conditions deteriorate," MARC chief economist Nor Zahidi Alias said in a statement yesterday.

He explained that such prospects will increase the appeal for local bonds due to their attractive yields and Malaysia's benign inflation outlook. As such, Zahidi expects annual cumulative foreign flows into local bonds to improve from their levels in 2016-2018.

"Hence, it will mitigate some of the outflows that could happen in 2H2019 due to rising concerns over the US-China trade war and FTSE Russell's possible decision to exclude Malaysian government bonds from its global bond index.

"We expect the 10y MGS yield to hover between 3.5%-4% in 2H2019," he added.

BNM cut its key interest rate to 3% in May, from 3.25% previously, marking the first time it has revised the rate in over a year since Jan 25, 2018.

The US Federal Reserve (Fed) on Wednesday lowered its interest rate for the first time since the global financial crisis in 2008, reportedly to help stave off the possibility of an economic downturn.

It was reported that the Fed was hoping that a rate cut will be the necessary injection to keep the US economy healthy, especially because it has limited ammunition to respond to a downturn with historically low interest rates.

On this, Zahidi said the reduction was less than expected, particularly because US Fed chairman Jerome Powell emphasised that the cut only serves to "insure against downside risks" but did not signal the start of an easing monetary policy cycle.

However, Zahidi pointed out that although the US economy remained generally robust in the first half of the year, possible weaknesses in the second half of the year may in fact result in the Fed trimming the rates further.

"Recent macro releases look less comforting i.e. the leading index contracted at the fastest pace since 2016, gross private domestic investment slumped by the most since 2015 in the second quarter and yield curves continue to invert," he explained.

Zahidi said the rate cut will have important repercussions on capital flows into emerging markets.

"For example, declining net foreign outflows from the Malaysian bond market in 1H2019 is partly associated with the outlook on the weaker greenback on the back of rate cuts that are expected to happen in 2H2019 in the US," he added.

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