Lure of Malaysia’s high-yield bonds

Foreign holdings bonds

PETALING JAYA: Malaysian government bonds, which are among the higher-yielding ones in the region, will continue to attract foreign interest in the medium term.

This trend will also be backed by improving sentiment as economic activities continue to rebound, while global liquidity remains high, analysts say.

A bond trader with a local brokerage pointed out that the US Federal Reserve’s decision to keep interest rates near zero for a longer period, plus the prospect of a weakening US dollar, should benefit Asian bonds, which offer better returns.

“Suppressed yields on US Treasury bonds will drive demand for Asian government debts.

“And Malaysian local government bonds will benefit as they are among higher-yielding ones, ” the trader told StarBiz.

“In addition, investor sentiment has improved as economies in the region are recovering after the Covid-19 lockdowns; hence, the growing appetite for Asian assets, ” he added.

Similarly, RHB Research wrote in its report: “Malaysia remains attractive amid its high yields and better domestic recovery. In addition, the waning appeal for US dollar assets lends support to regional currencies in general.”

“However, risks remain – this is with respect to the FTSE Russell’s decision in September (on whether) to keep Malaysia in its World Government Bond Index, ” it added.

Foreign investors remained net buyers of Malaysian bonds for the fourth consecutive month in August, albeit at a slower pace than the preceding month.

RAM Rating Services group economist Kristina Fong (pic below) noted that global uncertainties concerning economic recovery momentum remained and thus, volatile capital flows – stemming from portfolio re-allocations by active investors – would not be completely unexpected.

“That said, foreign investor appetite in Malaysian bonds has been revived in recent months after the knee-jerk outflow in March, ” Fong said.

“This trend is mostly anchored by a return in index-based investors to the market. Unless there are major changes to Malaysia’s weightage on global market bond indices, this fundamental demand is likely to be sustained, ” she added.

Bank Islam Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid said the potential cut in the overnight policy rate (OPR) meant that there is a prospect for capital gains since interest rates and bond prices are inversely related.

The ringgit undervaluation also implied potential gain that could be made from the currency market, he added.

“Bank Negara has the space the reduce the OPR as inflation rate is low and economic uncertainty remains high. Apart from that, the US dollar/ringgit is still undervalued, ” Afzanizam said, adding that the average US dollar/ringgit stood at 3.62 since the currency peg was removed in July 2005.

“Theoretically, there is always an upside potential for ringgit should the currency revert to its mean (of 3.62 against the US dollar), ” he explained.

Foreign inflows into ringgit bonds stood at RM3bil in August, compared with RM7.1bil in the preceding month. As a result, total foreign holdings rose to RM209bil last month, the highest since March 2018, while the share of foreign ownership of ringgit bonds rose to 13.3%, a seven-month high.

By instrument, the debt market was driven by Malaysian Government Securities (MGS), which attracted total net foreign inflows of RM3.2bil last month. This, however, was partly offset by an outflow of RM200mil from Government Investment Issues (GII).

Foreign ownership of MGS rose to a six-month high of 39.2% as at end-August from 38.2% in the preceding month.

Expecting investors to increase their hunt for higher yields, Kenanga Research said the local debt market would continue attracting foreign demand over the medium term.

“We expect net inflows to continue in the the second half of 2020 due to a sustainable increase of demand for higher-yielding bonds. This is in spite of our year-end US dollar-to-ringgit exchange-rate forecast being maintained at 4.30 (versus 4.09 last year) because of local political uncertainty, the US dollar potential upside post-election and the re-emergence of Covid-19 cases globally, ” Kenanga Research explained in its report.

Last month, the US 10-year Treasury average yield rose four basis points (bps) to 0.66%, as new US debt issuance, coupled with upbeat US economic data, weighed on trading, pushing prices lower and driving yields higher.

In line with robust foreign demand, the 10-year MGS average yield fell 13 bps to 2.51% in August. This narrowed the average yield spread to 186 bps last month from 203 bps in July.

Meanwhile, Maybank Kim Eng said the increase in Malaysia’s weight in the Government Bond Index-Emerging Markets (GBI-EM) Global Diversified index at end-August’s rebalancing probably helped boost demand for ringgit bonds.

According to Maybank Kim Eng, Malaysia’s index weight in GBI-EM Global Diversified could continue to rise to around 7.5%-8.0% by the end of the year from the estimated 7.3% at end-August, given the dilution effect from the phased-inclusion of China.

“This is a positive and timely development ahead of the FTSE Russell’s annual review in September. If liquidity improvement is indeed the reason for Malaysia’s rising index weight, it offers signs that Bank Negara’s measures to improve bond liquidity could be working, ” it said.

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