Volatility in bonds

UOB Asset Management chief executive officer Lim Suet Ling

WHILE the bond market has been relatively stable in recent weeks since recovering from a major selloff in the first quarter of the year, pressure is seen rising again towards the end of 2021, as investors price-in the risk of tapering and interest rate hikes by the US Federal Reserve (Fed).

Locally, the expected increase in bond issuances will also cause volatility in the market.

“At the moment, the relatively stable and range-bound movement in the US Treasury is positive for the local bond market... but there could be some downside risk posed by a potential tapering by the Fed,”

Affin Hwang Asset Management senior portfolio manager for fixed income, Ahmad Raziq Ab Rahman, says.Affin Hwang AM expects the Fed to start communicating its quantitative easing (QE) tapering plan next month. It says the Fed could look at tapering its massive bond-buying programme by early 2022. This could lead to higher volatility in markets and a spike in US Treasury yields, and in tandem, an increase in Malaysian bond yields.

The benchmark 10-year Malaysian Government Securities (MGS) yield is currently hovering around 3.24%, compared with almost 3.5% in mid-March this year and 2.65% at end-2020.

The 10-year US Treasury yield, on the other hand, is presently hovering at 1.36%, compared with 0.93% at end-2020.

Pointing to the slew of fiscal stimulus measures since the start of Covid-19 pandemic, Ahmad Raziq notes there will be some implications to the country’s fiscal deficit, which is expected to be around 6.5%-7.5% of gross domestic product (GDP), compared with the government’s earlier target of 6% of GDP.

In addition, the statutory debt ceiling is also expected to be raised from 60% to 65% of GDP. “This could put some downward pressure to the country’s sovereign ratings. We could also see a bit more volatility in the local bond market because of the additional bond supply,” Ahmad Raziq says.

Rising pressure

During the first half of 2021, the local bond market registered a negative return, with the Refinitiv BPAM All Bond Index decreasing 1.7%.

UOB Asset Management chief executive officer Lim Suet Ling notes that during this period, local bond yields climbed higher in tandem with rising US Treasury yields on the back of rising inflation expectations and concerns over excess bond supply.

Amid greater supply pressure, Malaysian sovereign bond yields surged between six basis points (bps) and 79 bps during the first half of 2021 from end-2020.

At end-June 2021, for instance, the 10-year MGS yield stood at 3.28%, up 63 bps from end-2020.As for shorter-tenor securities such as the three-year MGS, yield rose 40 bps to 2.27%, while five-year MGS yield rose 44 bps to 2.54%.

For the remaining part of this year, Lim reckons, shorter tenor securities in the domestic bond market are expected to remain supported by stable policy rate and uncertainty arising from the Covid-19 pandemic.

Longer-tenor securities, on the other hand, could continue to face pressure from the potential increase in global bond yields and less favourable supply-demand dynamics, she says.

As it stands, Bank Negara is widely expected to keep the benchmark overnight policy rate (OPR) unchanged at a record low of 1.75% through the remaining part of 2021, given targeted domestic measures to support an uneven recovery.

On inflation, Lim says, the consumer price index is expected to rise sharply in the near term, driven by both base effects and global supply constraints as the world tries to normalise after partially closing capacity in 2020.

“There is an expectation that the rise in inflation rate is transitory and inflation would moderate when the base effect wears off.However, if the inflationary pressure prolongs, this would be negative for bonds,” she adds.

Favourable quality

Amid the volatile landscape, Eastspring Investments Bhd chief investment officer Doreen Choo says she prefers liquid, high-quality bonds such as government, government-guaranteed and AAA-rated securities to manage fund liquidity and credit risk.

The group is selective on lower-rated credits, as the economic slowdown may put pressure on corporate’s credit metrics and favours sectors with inelastic demand and resilient cashflows.

“In the near term, bond yields are expected to remain volatile, as investors continue to tussle with the worsening pandemic situation and an economy that has been under prolonged lockdown,” Choo says.

On balance, she still sees a steepening bias in Malaysia’s sovereign yield curve, where the shorter-end of the curve continues to be anchored by Bank Negara’s accommodative monetary stance, while the longer-end of the curve will remain under pressure on slower economic recovery, potential fiscal slippages and unfavourable demand-supply dynamics.

While Eastspring expects Bank Negara to keep the OPR unchanged through 2021, it does not discount a rate cut if the central bank deems it necessary based on weak economic data.

“A low interest rate environment encourages issuers to tap the bond market at lower financing cost and this will provide more depth and supply to the bond market,” Choo says.

Financing deficit

Maybank Kim Eng (Maybank KE) recently raised its gross MGS and Government Investment Issue (GII) issuance forecast by RM5bil to RM165bil for 2021.

According to Maybank KE fixed-income research head Winson Phoon, if Malaysia’s fiscal deficit were fully funded by MGS and GII, gross issuance could be as high as RM175bil.

At present, though, he says, his team still thinks the fiscal deficit will be partly funded by Malaysian Treasury Bills (MTB) or Malaysian Islamic Treasury Bills (MITB).

Phoon notes there is a possibility of the government rolling out further stimulus packages in the coming months.

“The Pemulih package may not be the last stimulus this year if the government announces another ‘recovery package’ when the economy reopens, although this would depend on the timeline of the reopening as Budget 2022 will be tabled in October,” he says.

Malaysian Rating Corp Bhd (MARC) projects gross issuance of MGS/GII to be around RM170bil to RM180bil this year.

The rating agency says the local bond market is likely to record net foreign inflow in 2021, albeit at a smaller magnitude compared to last year.

“We do not expect the local bond market to record net foreign outflow for 2021 despite expectations of slower-than-expected economic growth for 2021 due to the implementation of a total lockdown, as Malaysia is still poised for a strong rebound,” MARC says.

“Positive progress in Malaysia’s vaccination drive and FTSE Russell’s decision to retain Malaysia in the WGBI (World Government Bond Index) will continue to attract foreign interest in local bonds,” it explains.

Mildly bearish

Maybank KE maintains a “mildly bearish” outlook on MGS, but is “neutral” on duration.

The group is of the opinion that the OPR has bottomed out at 1.75% in this rate-cut cycle and the threat of rising Covid-19 infections can be offset by an accelerated vaccine rollout.

“Unless US Treasury yields plunge further, there appears to be little domestic catalyst for bonds,” Phoon argues.

He notes the correlation between regional yields and US Treasury yields has reduced amid the extended Asean foreign exchange weakness against the US dollar.

The brokerage maintains a cautious view on foreign holdings of ringgit bonds, expecting choppy foreign flows, with moderate net foreign selling in the second half of 2021.

“We still expect the MGS curve to bear-flatten in the next three to six months when sufficiently high vaccine coverage reduces the threat of Covid-19 to Malaysia’s economy,” Phoon says.

Near term, he expects the benchmark 10-year MGS yield to stay in the 3.10%-3.30% range. The yield is expected to increase over the medium term to end the year at around 3.50%.

MARC, on the other hand, expects the 10-year MGS yields to be around 3.50% to 3.60% by the end of the year.

“MGS yields would be pressured by ongoing debates on tapering programmes from global central banks, heightened inflationary pressure, growing new supply of MGS and waning buying support from the EPF (Employees Provident Fund),” it explains.

Foreign inflows in ringgit bonds totalled RM24.6bil for the first half of 2021, exceeding the amount registered for the entire 2020 of RM18.3bil.

As of end-June 2021, foreign holdings of ringgit bonds stood at RM247.5bil; foreign shareholding of MGS was 40.4%, compared with 40.6% as of end-December 2020.

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