Bond yields seen at elevated levels

  • Business
  • Saturday, 24 Dec 2016

THE Malaysian government securities (MGS) yields will remain at elevated levels in the first half of next year although the outflow of funds from the bond market may not be that severe as last month as much will depend on the strength of the ringgit, the direction of the US interest rates and US treasury yield trends.

RAM Ratings head of research and economist Kristina Fong tells StarBizWeek MGS yields will likely remain elevated next year, more so in the first half compared to the second on the back of prevailing uncertainties as major global events unfold.

“We feel that investors will be watching out for President-elect Trump’s policy manoeuvres during his first 100 days in office, the development of Brexit negotiations once Article 50 is triggered in March, US’ policy rate decisions following major data releases in March and June, the next Opec meeting in May, election outcomes in Europe and domestically, the progress in the development of the onshore forex hedging market,’’ she adds.

Bond yield movement

Corporate bond yields, Fong notes, have generally moved in tandem with MGS yield movements this year despite having a significantly lower degree of foreign investor participation.

With the rate normalisation cycle in the US finally cranking up on the back of an improved macro environment, she expects a larger chunk of global fund flows to head in that direction. As such, bond market outflows are likely to continue next year albeit not expected to mirror the extent of the net sell-off seen in November of almost RM20bil, Fong adds.

At the time, the market contended against numerous selling pressures, triggered by the uncertainties following President-elect Trump’s election victory, expectations of a US policy rate hike and domestically, foreign investor concerns regarding the return to capital controls following Bank Negara’s clampdown of the offshore NDF market. She says sturdier oil prices next year may provide some upside support for the ringgit but feels that investors may still put more weight on Fed rate hike decisions with respect to their portfolio allocation decisions

CIMB Group head of treasury and markets Chu Kok Wei says ringgit bond rates have also retraced from the spike seen during the initial ‘knee-jerk’ reaction to the result of the US Presidential elections which was seen as overdone.

Going into 2017, Chu adds he expect rates to rise over the medium term on the longer end of the curve, and shorter dated yields in the MGS and corporate to be supported and dependent of Bank Negara policy and the pace of domestic inflation. CIMB’s Fixed Income Research expects 3-year MGS to close at 3.25% and 10-year MGS within 4.25-4.50% by end- 2017.

“Going into 2017, global geo-political risks remain at the forefront of events of interest, with United Kingdom’s ongoing negotiations to exit the European Union and key European elections in countries such as Germany, France, Norway and Netherlands.

“We expect the Federal Reserve’s policymakers to be cognisant of global risks and continue to be data-dependent in their consideration on further rate hikes. Economic fundamentals in Asia continue to remain relatively stable and we expect yields in the Malaysian bond space to rise gradually within priced-in expectations of Fed increases in a gradual manner rather than that with an aggressive trajectory,’’ he says.

Based on Bloomberg data, the benchmark 10-year MGS yields on Friday was at 4.3%, after charting a high of almost 4.5% on November 29, and the ringgit closed at 4.47 against the US dollar.

Meanwhile, Affin Hwang Capital Research in a note on December 8 said market observers were concerned about capital outflows as the levels of foreign holdings in MGS remains high at 48.4% as at end-November 2016 (51.5% as at end-October 2016). The foreign holdings of MGS fell by RM11.5bil to RM173bil as at end-November, whereas the total foreign bond holdings (including MGS) declined by RM19.9bil to RM221bil as at end-November.

Hongkong and Shanghai Banking Corp Ltd head of global EM rates research Andre de Silva says in view of the recent global US dollar strength, the ringgit has underperformed regional peers as

concerns over Malaysia’s external balances have again returned to the fore which has weighed negatively on Malaysia government bonds. The story for early 2017 is likely to be the same, he adds.

“Foreign investors might become reluctant to roll over their maturing government bond holdings as they prepare to shift from offshore to onshore currency hedging. This could result in Malaysia government bonds underperforming regional peers as bond maturities will jump 37% in 2017 to RM66.8bil, up from RM48.7bil in 2016. The country’s high ratio of foreign ownership of government bonds could become a drag and lead to higher yields and steeper curves,’’ de Silva notes.

Bond Pricing Agency Malaysia Sdn Bhd (BPAM) CEO Meor Amri Meor Ayob, however, opines that upside risk to higher bond yields could be limited in 2017. This is because the market had seemingly priced in most of their expectations of the three rate hikes by the U.S. Federal Reserve (Fed) next year, he says, adding that as such, the possibility of another round of a 60-70bps spike within a very short period in the 10-year U.S. Treasury yield as observed since Donald Trump’s presidential election victory is remote.

Furthermore, Meor says Trump recently nominated a conservative Republican Congressman Mick Mulvaney as his budget director and the latter advocates cutting government spending and was in the past against raising the fiscal debt ceiling.

However, he says investors should not expect the 10-year U.S. Treasury yield to fall below 2% again in the near future as persistent selling of U.S. Treasuries by sovereign entities like China and Saudi Arabia will limit the fall in the U.S. Treasury yields.

“MGS yields, and to a certain degree the corporate bond yields will likely follow the U.S. Treasury yield trend mentioned above as they are positively correlated. As long as the U.S. Treasury yields do not go higher, MGS yields will stabilise as well.

“If the 10-year U.S. Treasury yields keep rising substantially from the current level of around 2.50%, we expect MGS yields to increase as well due to foreign fund outflows as the percentage of foreign holdings in MGS is still very high,’’ Meor adds.

Bonds issuance and debt tenure in 2017

On bonds issuance, CIMB Investment Bank Bhd senior managing director and global head of capital markets Nor Masliza Sulaiman says if there is sustained economic growth in 2017 and is within the government’s target gross domestic product (GDP) growth range of 4%-5%, then primary ringgit denominated corporate bond offerings will remain healthy and reach RM80-90bil next year, which is higher than the total year-to-date 2016 ringgit denominated bond offerings totalling RM76.2bil.

“About RM41.1bil of ringgit denominated corporate bonds are due for maturity in 2017. We expect debt-raising exercises next year to largely come from infrastructure projects such as those from the power sector, highways and railways, which are expected to provide the push-factor for corporate bond issuances. We also expect banks to raise fresh capital, while the remainder should come from corporates of various industries for expansionary purposes.

On the demand for the type of bonds tenure, Masliza feels longer dated tenures will continue to sustain interest next year. Growth of issuances of longer-dated bonds grew in 2016 compared with 2015, and as such she expect this trend to sustain given the long-term infrastructure project financing in the pipeline and the ample liquidity in the ringgit market.

Assets under management growth remains positive for fixed income investors and we foresee demand from certain investor classes to remain healthy in longer duration instruments in their search for higher yielding assets, she explains.

Meor believe that the long dated bonds (20-year and above) will still hold up well in 2017 as this tenure point is sought after by pension funds and insurance companies. Moreover, this long dated tenures has also seen limited issuance in terms of supply to date, he says.

Fong says, RAM projects gross issuance of government securities to edge up slightly next year to RM100-110bil on the back of the government’s financing needs. Gross corporate bond issuance on the other hand is expected to continue at a similar pace to 2016 where the bulk of issuance originating from the financing institutions and infrastructure and utilities sectors, she adds.

The expected RM75-85bil in gross corporate bond issuance is reflective of ongoing development financing needs in infrastructure projects as well as the financial services sector’s continued expansion of the capital base.

In terms of tenure, Fong says: “As the panic selloff spurred by the ‘Trump Tantrum’ subsides, we expect shorter-tenured bonds to spark more investor interest in order to limit duration risks in light of continued uncertainties. The flatter yield curve compared to last year also makes shorter tenured bonds more attractive on a risk-return basis.”

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