Fed alterations increase uncertainty

(FILES) In this file photo The Federal Reserve building is seen on March 19, 2021 in Washington, DC. The largest US financial institutions have sufficient capital to continue lending during a severe economic downturn, the Federal Reserve said on June 24, 2021 as it released the results of its latest stress tests. The 23 banks that took part in the annual trials gauging whether they could maintain capital requirements in hypothetical economic crises all passed, remaining "well above their risk-based minimum capital requirements," the Fed said in a statement. Daniel SLIM / AFP

In mid-June after a two-day meeting of the Federal Open Market Committee, the Fed announced it would keep the base interest rate at a near-zero margin to continue supporting the economic recovery.

There were a number of changes announced at the meeting.

Firstly, the Fed reaffirmed that inflation can still increase and stay high in the coming months. However, long-term inflation is expected to increase but still within target. At the same time, it raised its inflation forecast for 2021 from 2.4 per cent to 3.4 per cent.

Secondly, the labour market is showing signs of a better recovery than expected. However, this threshold is still far from full employment.

The GDP growth outlook in 2021 is also raised to 7 per cent from 6.5 per cent. Interest rates are forecasted to double in 2023 to 0.6 per cent instead of by the end of 2023 as laid out in the previous meeting.

Regarding the asset purchase programme, the Fed still maintains the bond buying scheme of $120 billion per month, and will continue to have discussions about buying bonds in future meetings.

“Although the Fed has had a significant change in the US economic outlook in 2021 in a more positive direction in terms of both employment and labour, asset repurchase programmes are still being conducted regularly,” an industry insider commented. “And at this time, the effects and concerns from changes in monetary policy are still more short-term in expectation rather than a long-term effect on financial markets. This is further confirmed when the labour recovery has not yet reached the target level.”

According to Dr. Nguyen Thanh Binh, senior programme manager for the School of Business and Management at RMIT International University Vietnam, given the faster-than-expected rebound of the US economy, the Fed has signalled to increase the interest rate by the end of 2023.

“The projected tightening of the monetary policy would come sooner than previously expected, as the Fed indicated that interest rate would stay near zero into at least 2024 in previous communications. Moreover, there is indication that the Fed is starting to consider the current bond purchasing programme and could potentially reduce it if the US economy gets back on track in terms of employment sooner than expected,” Binh told VIR.

The potential change in the monetary policy stance combined with the evolving situation with the pandemic substantially increases economic uncertainty. If the market detects indications that the Fed plans to reduce its asset purchase programme sooner than expected, a sell-off in the financial market and the strengthening of the US dollar is a likely scenario which could also have negative ripple effects on the Vietnamese financial market.

“Moreover, the recent increase in COVID-19 infections in Vietnam has made a dent in the economic recovery and it remains to be seen how Vietnamese policymakers will react to the detrimental impact of the pandemic while the strengthening of USD in the near future has become more likely. All macroeconomic signs point towards a volatile summer in both the global as well as the Vietnamese financial market,” Binh highlighted.

Experts at UOB also voiced their concerns over the uncertain outlook posed by a new wave of COVID-19 cases in Vietnam.

It is likely for the SBV to stay put for now. As the situation is expected to be managed well just like it had done in 2020 and along with higher vaccination rollouts, the SBV is likely to keep its policy stance steady. Both the refinancing rate at 4.0 per cent and rediscounting rate at 2.5 per cent are at record lows.

One factor to watch is Vietnam’s inflation rate, which has risen to 2.9 per cent on-year in May versus 2.7 per cent in April. This is the fastest since September, and driven largely by transport (9.7 per cent) and housing (18.8 per cent), but offset by soft food prices (33.6 per cent) which have been on a downtrend since surging at double-digit pace in most of 2020.

While the forex (FX) manipulator label of Vietnam was dropped in April, the US Treasury will continue enhanced engagements with Vietnam on FX practices. Furthermore, the SBV has also reduced the frequency of its FX intervention (to keep the VND from rising) to once a week instead of daily from February.

“All these means that while the upcoming Fed taper may weigh on the VND, depreciation pressures on the VND would be limited as it invites scrutiny from US authorities. Our updated USD/VND forecasts are 23,000 in the third and fourth quarter of this year, followed by 23,100 in the first quarter of 2022 and 23,200 in the second quarter of 2022,” UOB highlighted.