Key Points
The combination of high US yields, geopolitical risks in the Middle East, and rising domestic political risks are putting some near-term downward pressure on the ringgit. While our base case is for the Middle East conflict to be contained rather than developing into a full-blown regional war, oil supply disruptions could keep inflation concerns alive globally and delay Fed easing. Indeed, tanker flows through Hormuz have collapsed after the June ceasefire Memorandum of Understanding between US and Iran collapsed early this month.
However, we look for ringgit weakness to be contained, given Malaysia's supportive growth backdrop, contained inflation, strong external sector, and prudent policymaking, which should help prevent disorderly currency depreciation.
Despite a tougher external backdrop, Malaysia remains one of the stronger-performing economies in Asia. Malaysia’s economy grew 5.8%yoy in Q2, picking up from 5.4% in Q1, despite the Middle East conflict. Notably, Malaysia’s economy has been operating above 4.9% trend growth for the last 4 quarters. Comparing across the region, Malaysia emerges as the 3rd best performing economy in Asia. Reflecting this, there was strong demand for Malaysia’s $1.5bn sukuk issuances. They are 4.7x oversubscribed, while pricing is tightened by 30bps from initial pricing guidance, achieving the tightest sukuk spreads. Final pricing is 15bps above comparable treasuries for 5.75y sukuk and T+25bps on the 10y tranche.
Economic growth continues to be supported by a combination of healthy household consumption, rising wages, low unemployment rate, and robust investment activity. In particular, the electronics sector remains a key beneficiary of the global technology investment cycle, with Malaysia's electrical & electronics exports continuing to track higher global demand for computing equipment and AI-related infrastructure.
Importantly, domestic inflation remains relatively contained compared with many regional peers. Government fuel subsidies continue to shield consumers from volatile energy prices, helping preserve household purchasing power and reducing pressure on Bank Negara Malaysia (BNM) to tighten policy. Headline inflation was only 2%yoy in June.
The combination of above-trend growth and moderate inflation provides Malaysia with one of the more balanced macroeconomic profiles in the region. We expect BNM to maintain a neutral policy stance and keep the Overnight Policy Rate unchanged at 2.75%. Policymakers have little urgency to adjust policy and we take the view that markets may have overpriced the chances of a BNM rate hike. Higher energy prices could actually improve oil related government revenues given Malaysia's status as a net energy exporter. This provides additional fiscal flexibility to maintain fuel subsidy programmes and limit cost pass-through effects to consumers.
From a currency perspective, authorities have also demonstrated a willingness to smooth recent excessive FX volatility. Similar to measures implemented in 2024, we expect continued efforts to encourage export conversion and repatriation flows by government linked corporates should the ringgit come under excessive pressure.
While economics remains supportive, domestic political developments could become a more important driver of USDMYR over the coming months. Political uncertainty surrounding state elections, party coalition dynamics, or speculation around the timing of a future general election could generate periods of temporary ringgit weakness. Following the Johor state election on 11 July where the ruling PH coalition party has a poor showing, the upcoming Negeri Sembilan state election on 1 August will serve as a key political signal. Heightened election and political uncertainty could introduce a higher risk premium on the ringgit.
