Long-term bonds under pressure

Fed rate hike may resuly in a self-off, say economists

PETALING JAYA: Long-term government bonds such as the Malaysian government securities (MGS) and government investment issues (GII) are set to come under pressure in the near term as net selling of these instruments by foreign investors are expected to pick up.

Bond strategists and economists concurred that the latest hike in interest rate of 75 basis points (bps) by the US Federal

Reserve (Fed), the third consecutive cut to combat inflation that remains near a 40-year high, could result in the sell-off of MGS and GII as foreign funds look for higher yields in US dollar bonds.

However, they agreed that the sell-off would not be as significant as in the first half of the year. MGS and GII currently make up the bulk or about 90% of overall foreign holdings of Malaysian government bonds.

The flight to safety sentiment among foreign funds had led to a consistent sell-off of government bonds domestically as well as among emerging market (EM) peers since the start of the year (see chart).

Foreign appetite for emerging market bonds had made a comeback in August with net purchases of MGS and GII (Rm3.6bil), Malaysian Treasury Bills (MTB) and Malaysian Islamic Treasury Bills (MITB) (RM1.9 bil), and corporate bonds (Rm69.1mil).

MTB and MITB are short term government securities.

Total net foreign holdings rebounded in August to Rm5.6bil following two consecutive months of net outflows that saw funds pulling out of EMS.

RAM Rating Services Bhd senior economist Woon Khai Jhek told Starbiz foreign-nvestor interest was expected to remain weak in the

near term as the high interest rates in the US would likely continue to drive foreign funds into US assets.

He said the sell-off pressure is not expected to be as pronounced as seen in the first half of the year given that interest rate expectations are likely to have already been somewhat priced-in.

“Investor sell-off of EM assets is likely to also subside once the risk-off sentiment dissipates among foreign investors, which should help support the appeal of Malaysian bonds,” he said.

Notably, he said the improvement in investor sentiment in August already led to a sizable foreign net inflow of Rm5.6bil into the Malaysian bond market in the same month.

Risk-off sentiment is where investors readjust positions to take on less risk.

According to Maybank Investment Banking Group head of fixed-income research Winson Phoon, the foreign positioning in ringgit bonds is not heavy and outflow pressure has been mild.

“A global synchronised tightening in monetary policy means there are several places to hide in this environment.

“In fact, many EMS Asia local currency bond markets such as China, Malaysia and Indonesia, have outperformed the US Treasuries (UST) in total return year-todate. Going forward, we expect the monthly foreign flow pattern to remain choppy,” he said.

In terms of yield differentials between the MGS and UST, he said the 10-year MGS-UST spread has tightened considerably to below 70 bps from 208 bps at the beginning of the year due to monetary policy divergence between the Fed and Bank Negara.

The yield spread could remain tight until a dovish pivot by the Fed.

Phoon said the 10-year MGS yield would likely fall below 4% from 4.2% in the next three to six month.

RAM Rating’s Woon said while MGS yields were on an uptrend in line with the domestic policy rate hikes, the pace of increase has been slower than those of the UST yields which were boosted by the aggressive policy rate hike in the United States.

This had led to the narrowing of the yield spread between the 10-year MGS and UST securities to an average of 106 bps in August from an average of 190 bps at the start of the year.

In general, investors would use the spread to gauge the “investability” of the bond as UST is known to be a “safe haven asset”.

The spread should be sufficiently wide to appeal to investors to take up a higher “risk” asset.

However, there is usually no fixed value for the spread and it would depend on the time and what investors perceived to be palatable.

“With the Fed maintaining its aggressive hawkish stance and investors continuing to bet on more rate hikes, the upward pressure on the UST yields is likely to persist.

“As the rise in the overnight policy rate (OPR) and domestic yields is not expected to match those of the United States, it will limit the possibility of any significant widening of the yield spread in the near term,” he noted.

The OPR stands at 2.5% compared with the federal funds rate of 3% to 3.25% with the latest 75 bps rate hike.

As for corporate bonds, the rating agency is projecting a gross issuance of Rm110bil to Rm120bil this year (2021: Rm114.3bil), propelled by private refinancing initiatives, continued infrastructure financing needs and financial institutions’ capital augmentation plans.

As of end-august, the total corporate bond issuance amounted to Rm73.5bil.

Based on the current momentum, Woon said corporate bond issuance are on track to meet RAM’S projected range for this year.

MGS and GII issuance is projected to rise Rm165bil to Rm175bil in 2022 (2021: Rm163.9bil), taking into account the government’s larger deficit financing requirement as well as the refinancing of debts maturing next year, he said.

As of end-august, the MGS and GII issuance totalled Rm118.5bil.

For corporate bonds, the full=year issuance is expected to come in at Rm110bil to Rm120bil.

On the overall outlook for the Malaysian bond market, Phoon said: “We recommend real money investors with holding power to buy the dip on MGS/GII duration as a hedge against growing global macro headwinds and risk of a recession.”