A Case For Appreciation Of The Ringgit

Ringgit was traded in the last 2 weeks around RM4.45, the weakest in 5 years. In the first 7 months of this year, Ringgit weakened by -6.4% against the dollar, from RM4.17 as of end-2021.

A Case For Appreciation Of The Ringgit
Photo by Polina Tankilevitch

Citing strong economic fundamentals & elevated commodity prices, MIDF Research believes there is a case for an appreciation of the ringgit in the coming months.

"Fundamentally, the ringgit is on strong footing underpinned by firming domestic demand, robust external sector and elevated global commodity prices," it says.

It adds that unemployment rate is on descending trajectory, 3.9% in May-22 (2021: 4.5%), slightly higher than the pre-pandemic level 3.4%.

"Inflationary pressure in Malaysia remains stable, among others thanks to the capped retail fuel prices and other subsidy assistances.

"In addition, we foresee the moderation of food price inflation in 2HCY22 amid slight betterment in domestic food supply and correction in global commodity prices.

"We are optimistic that ringgit to appreciate in 2HCY22 and reach RM4.25 per USD by year-end, driven by the strong economic fundamentals and elevated commodity prices."

FED Strategy

Thus far, the recent weakness in ringgit was primarily due to the effect of the broad strength in USD.

A more aggressive policy tightening adopted by the Fed and the widening of interest differentials resulted in stronger demand for USD.

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As USD appreciated against other major currencies, the US dollar index (DXY) rose to 108.5 by mid-July 2022, the highest level in 20 years.

Consequently, ringgit was traded in the last 2 weeks around RM4.45, the weakest in 5 years. In the first 7 months of this year, Ringgit weakened by -6.4% against the dollar, from RM4.17 as of end-2021.

The USD/MYR was rather unperturbed by the 25bps hike in US Fed fund rate in March this year as it remined largely stable within a tight band of between 4.17 and 4.21 since early January.

However, the USD/MYR broke decisively above the 4.24 resistance level in the third week of April attributable to the heightened possibility of the US Fed raising the pace of interest rate hike in its early May meeting.

As it turned out, the US Fed announced a 50bps hike in May and the pace heightened further to 75bps in each of the June and July meetings. Meanwhile, the USD/MYR risen rather persistently to 4.45 as of last Friday.

The depreciating Ringgit against US dollar proved a blow to the pace of foreign inflow into the local equity market.

The cumulative YTD net foreign fund flow began to plateau since April and subsequently declined in June as the Ringgit continued to weaken. In tandem, the FBM KLCI saw its worst YTD monthly performance in June as it slumped -8.0% to 1,444 points level.

Undervalued Ringgit

The analyst firm also believes the ringgit is undervalued, based on real effective exchange rate (REER).

"The value of Ringgit at REER even fell further in 1HCY22. Looking at improving growth momentum, elevated commodity prices, and increasing domestic economic activities on the back of economic reopening, we believe the economic fundamentals are more in favor of stronger ringgit.

"This explains why Ringgit strengthened against other currencies according to nominal effective exchange rate (NEER). ringgit has been strengthening on NEER basis from the recent trough in May-21 when the full nationwide lockdown was imposed last year.

"Unfortunately, movements in the financial market, which are more sensitive to the US FOMC’s rate decisions, caused Ringgit to weaken specifically against the US dollars," it says.

Ringgit Resilience

The point is the ringgit is showing resilience against other currencies while it is facing a dip versus the U.S. dollar

Ringgit performed better mainly against other major currencies. From end-2022 until end-July 2022, MYR appreciated against EUR (+4.1%), GBP (+4.0%) and JPY (+8.4%). Ringgit performance against regional currencies is rather mixed; weakened against SGD (-4.2%), IDR (- 2.6%), and CNY (-0.7%), but strengthened against THB (+2.4%), KRW (+2.2%), PHP (+1.2%), and TWD (+1.2%).

"We believe the overall resilience in Ringgit performance, in line with the trend in NEER, reflects the positive effect of elevated commodity prices on Ringgit, particularly from the high prices of crude oil and palm oil," says MIDF.

Ever since the Ringgit de-pegged against USD on July 22, 2005, it has moved relatively in tandem with Brent price.

Oil and Ringgit

From that date until yesterday, the movement of USD/MYR and Brent have a correlation of -0.69, indicating a negative correlation i.e. when oil prices increases, Ringgit will appreciate and vice versa.

A stronger negative correlation can be found from data that range between 22 July 2005 and 31 December 2021, where the correlation is -0.80.

However, this relationship seems to have broken down this year where the correlation between USD/MYR and Brent is +0.45.

This suggests that as oil prices increases, Ringgit depreciates; despite Malaysia being an oil producing nation.

"It seems that the effect of US Fed decision has a stronger weight at current juncture than the past relationship between Ringgit and oil. However, we expect that this disconnect will not last and the Ringgit will eventually reflect the elevated oil prices."

While the jump in commodity prices earlier this year was mainly linked to supply constraints and the negative effect of war in Ukraine, the recent correction in commodity prices was due to two factors.

"First, demand outlook is weaker than previously anticipated due to concerns over recession risk in Europe and the US. In addition, consumers are adjusting their spending plans due to higher inflation and monetary policy tightening by central banks.

"Second, we believe there is limited upside pressure on commodity prices as the global supply chain activity is expected to improve," it says.

No Sharp Correction

While global supply condition would improve further as countries reopen their economies and international borders, "we don’t expect there will be a sharp correction in commodity prices.

"We believe prices will remain elevated, in view of the ongoing post-pandemic supply challenges and the war in Ukraine," says the analysts.

Furthermore, the recent rise in geopolitical tension between the US and China also contributed to supply concerns. On another note, the reduced support for USD in the latter part of the year, as market priced in smaller rate hikes in the coming FOMC meetings, will also limit declines in commodity prices, especially crude oil prices.