Higher bonds yields to extend into second half of year

PETALING JAYA: The Malaysian bond market, which saw about RM13bil of foreign outflows in May, could see continued selling by foreign funds extending into the second half of this year with yields for the 10-year Malaysian Government Securities (MGS) projected to hover between 4% and 4.5%.

Some bond analysts and economists told StarBiz they foresee continued selling pressure into the second half of the year due to further monetary tightening by major central banks, rising trade tensions between the US and its trading partners and the country’s RM1 trillion debt issue, causing yield spread between the 10-year MGS and 10-year US Treasuries to further narrow.

The narrowing of the yield spread is also due to the US Fed normalisation policy in the form of Fed rate hikes, while Bank Negara is maintaining its overnight policy rate (OPR) at its current level of 3.25%.

The US Fed raised its interest rates by 25 basis points to the target rate of 1.75% to 2% recently and has given guidance for two more rate hikes, bringing the total expected hikes to four this year. The 10-year MGS currently hovers at 3.73%. Bond yields and prices have an inverse relationship.

In May, the Malaysian bond market recorded the largest monthly foreign outflow since March 2017. Foreign investors reduced their ringgit bond holdings by RM12.9bil. That led to a decline in foreign holdings of Malaysian bonds as a percentage of total outstanding to 14.1% from the recent high of 16.1% in January 2018.

Maybank Kim Eng head of fixed income research Winson Phoon is forecasting the 10-year MGS yield to hover at 4.00% in the third quarter and 4.10% in the fourth quarter of this year.

“The spread between the 10-year MGS and 10-year US Treasuries has been narrowing from about 220-240 basis points (bps) in mid-2016, to about 150bps at end-2017 and to about 130bps currently.

“The narrowing of the spread is driven by the diverging monetary policy path, where the US Fed continues with rate normalisation while Bank Negara has kept OPR stable in the 3%-3.25% range,” he said.

However, Phoon said he was mildly bullish on MGS and forecast the yield to return to 4.00% area in the next three to six months.

Currently, he noted the MGS curve is priced with higher risk premiums (ie higher yields) due to post-general election (GE14) concerns such as policy uncertainty and the RM1 trillion debt issue.

“We don’t expect foreign selling to extend well into the second half, unless the broad emerging market (EM) risk sentiment deteriorates further. Foreign outflows in May was large at about RM13bil due to a combination of domestic post GE14 and external EM risk-off factors. Foreign sentiment toward Malaysia risk should improve gradually with policy clarity under the new administration,’’ he noted.

However, unlike Phoon, other bond analysts and economists think that foreign holdings of Malaysian bonds could continue to experience an outflow.

Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias noted that further portfolio capital outflows from the Malaysian bond market cannot be ruled out in the second half.

He said the pressure on financial markets in EM (Malaysia included) would likely persist in the second half if concerns over rising interest rates, trade-war jitters, possibility of currency devaluations worldwide, and political developments in some European countries persist. 

These concerns would drive investors towards safe-haven financial assets such as US dollar and Yen, and these two currencies could see further strengthening ahead, Zahidi said. 

“Yields for 10-year MGS should gradually rise alongside US Treasury yields, ranging between 4.0% and 4.5% in the second half of the year, though the magnitude of the rise will depend on the pace of the US Fed rate hike and the ringgit’s trend against the US dollar. 

“Notwithstanding the usual market jitters, we do not expect a sharp spike in yields. We expect Malaysia’s solid economic growth pace to continue driving the demand for ringgit bonds and help moderate the potential rise in ringgit bond yields, even against the backdrop of monetary normalisation by major central banks,’’ he said.

CIMB Investment Bank Bhd group head of treasury and markets Chu Kok Wei is projecting the 10-year Malaysian government bonds yields to be at 4.00% by end-2018 and down to 3.95% by mid-2019.

“The valuations of long dated bonds appear attractive at current levels, and we expect a flatter yield curve as growth and inflation are expected to soften in the next few months as mega-projects are reviewed and the government rationalises its spending, as well as after the zerorisation of GST on June 1. 

“Short-dated bonds may be affected negatively if the central bank decides to increase rates in line with the global movement towards interest rate policy normalisation. This remains unclear at this juncture because there are domestic growth and inflation considerations, apart from the external global tendency to raise interest rates,’’ Chu said. 

Meanwhile, RAM Ratings head of research Kristina Fong said EM assets, including Malaysian bonds, may not be so attractive going forward and a rebound in the second half of the year seems unlikely. 

Moreover, she said some lumpy maturities of MGS/Government Investment Issue ( GII) in the third quarter (RM21.2bil) and fourth quarter (RM14.5bil) would also be a key factor in reduced foreign bond holdings this year.

As for the outlook of the bond market, she said there could be some slowdown in quasi-government issuance in view of the new government’s focus on the nation’s debt position, especially off-balance sheet contingent liabilities which include some government-guaranteed bonds. 

However, RAM maintains its gross corporate bond issuance projection of RM90bil-RM100bil for 2018 while continuing to monitor developments as more details become available throughout the 100-day post-GE14 period.

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