• Markets faltered. The KLCI closed lower versus the previous week at 1,658, as US-China trade tensions again took the spotlight and China 2Q GDP offered signs of slowdown.

• Retail investors remained net buyers. Foreign participation saw a net marginal net outflow of RM6.9m, the first reversal in 5 weeks. Local institutional funds were also net sellers to the tune of RM50.9m, following on its previous week’s net selling of RM169.5m. Local retail investors were however more positive as they remained net buyers for the 2nd straight week, raising total YTD 2019 net buying to RM883m.

• Factors affecting the market. China GDP for 2Q19 came in at 6.2%, slightly below expectation. However, June monthly indicators signaled a stabilization in the offing, as retail sales, industrial output, and fixed-asset investment all rose more than expected. Meanwhile, the USD extended its losses amid ever firming expectations that the Fed will deliver at least a 25bps rate cut at its July FOMC meeting. On earnings front, Digi was the first KLCI component to announce its 2Q19 results, posting an expected net profit as ARPU recovered.

• The week ahead. The Federal Reserve is expected to lower interest rates at its 30-31 July meeting despite signs the US economic expansion remaining intact. However, a falling US government bond yields are sending a market signal to the Fed that its current funds rate may be too high. It also appears there are concerns about low inflation and weak growth from abroad spilling over into the US economy. At the moment, almost every major central bank, including the ECB and the Fed has adopted a dovish stance in response to the impact of trade tensions on the outlook for global growth. Overall, the ringgit looks a good bet for the week as it may continue to firm on USD weakness.

Yield continues to decline on lower rates expectation

Both the US Treasury (UST) and Malaysian Government Securities (MGS) yields have continued to decline since the start of the year. We highlighted earlier that the fall in yield has been driven by two key factors 1) global economic slowdown and 2) inflation running at below central banks’ targets. The yield on the 10-year UST rate has fallen sharply from 3.2% in January 2019 to the 2.0% level currently. The 10-year MGS meanwhile has dropped to 3.6% in July from 4.0% at the start of 2019 (refer Chart 2).

We think another new normal of lower rates for longer has set in with Central Banks now required to change its monetary policy setting. We think the Fed may tolerate a weaker USD to allow for higher inflation rate reaching its 2% target. The Fed currently has to take an “insurance” rate cut to protect the US economy – despite the stock market at record highs – from being derailed by a global slowdown, partly contributed by the US-China trade tensions.

We expect the ringgit to be a potential beneficiary of the widening spread between MGS and UST as shown in Chart 2, as Malaysian bonds attract demand. The MGS-UST spread has risen to 157 bps currently and is well above its 10-year median spread of 147 bps. We note that the elevated MGS spread in late-2016/early-2017 led to the ringgit rising from nearRM4.50/USD to RM3.85/USD level in 2Q18 (refer Chart 3). The ringgit is poised to take on the RM4.10/USD psychological level in the near term, in our view.

Source: BIMB Securities Research - 22 Jul 2019