Foreign flows into debt market recover in August

• Foreign holdings of MYR debts securities increased to RM250.4bn in August
• Foreigners bought RM3.1bn of MGS and RM3.2bn of GII
• Total portfolio inflow of RM7.65bn for equities and debt securities combined
• Yields to see gradual rise, uptrend still intact

Total foreign holdings of Malaysia debt securities increased to RM250.4bn at end-August. Malaysia’s overall foreign portfolio flows rose by RM7.65bn in Aug, marking the highest monthly net inflow since Jun 2020. Foreigners turned net buyers of domestic debt securities (+RM6.6bn) and equities (+RM1.05bn) last month.

Looking into details, foreigners bought MGS totalling RM3.1bn (Jul: -RM3.5bn; Jun: +RM0.4bn; May: RM2.4bn; Apr: RM4.7bn) and bought GII amounting RM3.2bn (Jul: +RM0.4bn; Jun: +RM0.3bn; May: -RM0.7bn; Apr: +RM0.5bn). Year-to-date (YTD), foreign holdings of Malaysian government bonds (MGS & GII) rose by RM23.9bn to RM226.1bn as at end-Aug, which was equivalent to 25.9% of total outstanding. For MGS, foreign investors held RM191.7bn or 40.3% of total MGS outstanding as at end-Aug while foreign holdings of GII accumulated to RM34.4bn or 8.6% of total GII outstanding. Meanwhile, other debt instruments that foreigners added to their portfolio in August were Malaysian Islamic Treasury Bills (RM0.13bn), and private debt securities (PDS) including private Sukuk (RM0.3bn).

As at end-Aug 2021, foreign investors bought RM6.6bn of Malaysian bonds (Jul: - RM3.6bn; Jun: -RM0.5bn; May: +RM1.8bn; Apr: +6.4bn). Meanwhile, August saw net foreign buying of Malaysian equities of RM1.05bn (Jul: -RM1.3bn; Jun: -RM1.2bn; May: -RM0.2bn; Apr: -RM1.1bn), the first time since June 2019. Domestic institutions turned net sellers in Aug at RM1.5bn (Jul: +RM0.5bn), whilst domestic retail investors bought RM0.5bn (Jul: +RM0.8bn), their 26th sequential month of net buy since July 2019. As a result, Malaysia recorded a larger overall foreign portfolio inflow of RM7.65bn (Jul: -RM4.9bn; Jun: -RM1.7bn; May: +RM1.6bn; Apr: +RM5.3bn) in July. Since the beginning of 2021, the cumulative bond inflows were RM27.6bn (Jan-Aug 2020: RM4.3bn) whilst foreign outflows from Malaysian equities amounted to RM5.5bn (Jan-Aug 2020: -RM20.4bn). This resulted in YTD 2021 net inflows of RM23.0bn (Jan-Aug 2020: -RM16.1bn).

Bank Negara Malaysia’s international reserves rose by USD5.2bn or 4.7% mom to an 81-month high of USD116.3bn as at Aug 30 2021 from USD111.1bn as at 30 July 2021. The reserves position is sufficient to finance 8.3 months of retained imports and is 1.3 times total short-term external debt. The increased was underpinned by a big increase in Special Drawing Rights (SDRs), as well as foreign currency reserves and other reserve assets. In ringgit terms, the BNM reserves hit a new record high of MYR483.6bn (+MYR21.8b).

Demand for UST was initially pressured in the lead up to the Jackson Hole Symposium, as investors anticipated a potential announcement of the US Fed’s tapering plans. Fed Chair Powell’s speech during Jackson Hole Symposium acknowledged US economy’s progress but once again talked down on inflationary worries, without spilling any clues on QE tapering’s timing or pace. This relatively dovish stance calmed fears of earlier-than-expected taper/ rate cut brought upon by few Fed Hawks speeches earlier. By the end of the Symposium, demand for UST rebounded. Month end effects roiled US Treasury market trading, leaving yields higher and the curve steeper despite waves of buying. US Treasuries closed mixed on the last day of trading for the month after showing early gains. Late weakness in UST followed from losses in European bonds on news some ECB officials wanted to discuss reduction in asset purchases. Benchmark UST 10YR bond yield rose as high as 1.314%, and ended the month at 1.3088%. 

The local bond market saw improved trading activities, particularly in the MGS space, partly due to month-end rebalancing flows amid a strengthening ringgit and easing concerns over the local political environment. The MGS curve bull flattened with the front-to-belly part of the curve staying largely unchanged while the back end fell 1–9bps. Notably, the 30-year domestic bond market was relatively active as buying interest were seen along the curve with short ends shaving ~1bps off yields while long ends flattened further led by the 20-year benchmark. The 3-year and 10-year yields closed at 2.341% and 3.208% respectively. The 10yr-3yr yield spread was at 86bps, 6bps lower for the month.

Three auctions conducted in August:

I. 30-yr Reopening of MGS 06/50, RM4.0bn (RM2.bn auction + RM2.0bn pp)

II. 7-yr Reopening of MGII 08/28, RM4.5bn

III. 3-yr Reopening of MGS 06/24, RM5.0bn

Yields to see gradual rise, uptrend still intact

The UST10-yr yields are expected to rise gradually and not sharply. This means the upwards trend on the yields will not witness the same velocity of movement that we would expect had there been real inflation fear. We envisage the US Treasuries to hover around the current levels for a brief period. As talk of tapering starts to intensify, both the front and the back ends of the yields could start moving higher.

Foreign investors would increase their holdings on the nation’s bonds when a clearer picture of the political situation emerges and a plus point would be a stronger economy in the fourth quarter. As for now, all eyes will be on the new Prime Minister Datuk Seri Ismail Sabri Yaakob’s policies and the necessary economic reforms he undertakes, as well as how the COVID-19 situation is handled amid the high cases. Foreign investors would like to see how differently the new government’s pandemic response would be in their risk assessment. The persistently high COVID-19 cases that resulted in national lockdowns have been one of the factors behind the waning foreign investor interest in the bond market over the past few months. The other factors are the political uncertainty as well as the repositioning of investor portfolios towards the United States to capitalise on the rising prospects of faster than expected interest rate normalisation.

Foreign demand for domestic bonds may remain slightly pressured in the near-term, due to the local COVID-19 condition. However, the probability of bond inflows returning in the coming months has increased, given improving domestic political stability and as yield differentials remain attractive

Once the uncertainties clear, the positive yield differentials over UST should support demand for MGS/GII. However, demand for longer tenures will be limited by the repositioning of global funds to avoid duration risks in anticipation of policy rate normalisation by the US Federal Reserve and European Central Bank. Ramped-up vaccinations, leading to a more tangible path of economic recovery in 4Q 2021 and 2022, should also help buoy sentiments for Malaysian securities later in the year.

For the rest of the year, the upside to foreign inflows is supported by the more tangible path to economic recovery in 4Q 2021 and 2022. With the pace of vaccinations rapidly picking up, we believe more businesses will reopen by then. In addition, the generous yield differentials favouring MGS and GII should attract some foreign investors. The yield spread of MGS over UST has widened substantially over the past few months, averaging around 195bps in August (January average: 155bps). This represented its highest level since October last year.

The downside risk on the mid-horizon is the quantitative easing (QE) tapering and the ensuing policy rate normalisation of central banks in developed markets. QE refers to the buying of longer-term bonds or securities by the Fed to increase money supply and spur lending and investment. By the Fed cutting back or tapering on its bond-buying, it can result in higher treasury yields in the US, hence luring foreign investors in emerging markets, including Malaysia, to seek higher yields or returns in the US. Bond prices and yields are inversely related.

Source: BIMB Securities Research - 9 Sept 2021