• Foreign holdings of MYR debts securities rose to RM263.2bn in February

• Foreigners bought RMo.5bn of MGS and RM1.7bn of GII

• Total portfolio inflow of RM5.9bn for equities and debt securities combined

• Malaysia bonds offer the best profile to seek cover

Foreign investors’ interest in Malaysian assets remained strong as foreign funds continued to raise their Ringgit bond holdings in February 2022 as total foreign holdings climbed to another new record high of RM263.2bn (Jan: RM260.1bn) or 14.9% despite the volatility in global yields and USD strength.

Foreign funds continued to raise their Ringgit bond holdings with another +RM3.1bn net addition in February (Jan: +RM3.5bn). Looking into details, February’s foreign debt inflows were largely into Government Investment Issues (GII) where foreign investors increased their holdings of GII by RM1.7bn (Jan: -RM0.3bn; Dec: +RM3.9bn) which made up 10.5% of total GII outstanding. Foreign holdings of Malaysian Government Securities (MGS) alone also marked a new all-time high level at RM194.6bn even though they snapped up just RM0.5bn worth of MGS last month (Jan: +RM4.6bn; Dec: +RM2.4bn). This brought overseas investors’ shareholding of MGS to 39.3% of total MGS outstanding. This resulted in foreign holdings of Malaysian government bonds (MGS + GII) jumped for the third straight month by RM2.2bn to a new all-time high of RM240.4bn as at end-Feb and equivalent to 25.8% of total government bonds outstanding. Foreign holdings of discount instruments increased +RM0.8bn while PDS had small inflow of +RM0.1bn. Cumulative inflows for Jan-Feb amounted to RM6.6bn.

As at end-Feb 2022, foreign investors bought RM3.1bn of Malaysian bonds (Jan’22: +RM3.5bn; Dec’21: +RM6.2bn; Nov: -RM3.6bn). Meanwhile, foreign investors continue to enter Malaysia equity market as foreign investors bought a net RM2.8bn of local equities (Jan’22: +RM0.3bn; Dec’21: -RM1.1bn; Nov: +RM0.2bn). As a result, Malaysia recorded overall foreign portfolio inflow of RM5.9bn in February 2022 (Jan’22: +RM3.8bn; Dec’21: +RM5.1bn). Year to date, foreign portfolio inflows amounted to RM9.7bn in the first two months of 2022 driven by resilient demand for debt securities and a return of buying interest in equities.

Bank Negara Malaysia’s international reserves fell for the second consecutive month by USD0.3bn mom to a five-month low of USD115.8bn as at end-Feb (end-Jan: -USD0.8bn mom to USD116.1bn). This resulted in a cumulative decline of USD1.1bn in the first two months of 2022. In ringgit terms, the value of BNM reserves continued to decline for the third straight month, falling by RM1.4bn mom to RM482.3bn. The latest reserves position is sufficient to finance 6.1 months of imports of goods and services and is 1.2 times total short-term external debt.

US Treasuries rallied strongly into its month-end, led by heavy volumes seen in futures as safe-haven bids took centre-stage following sanctions imposed by the West on Russia and its continued tensions with Ukraine. The curve shifted sharply lower as overall benchmark yields ended between 11-15bps lower. Both the UST 2Y and much-watched UST 10Y yields plunged 14bps each to 1.43% and 1.83% respectively, pushing the UST2s/10s spread to narrow to 40bps from 60bps in January as sign of slower economic growth ahead as more sanctions were imposed on Russia. The 2-year yield’s plunge suggests that the Fed may be constrained by tightening financial conditions despite surging commodity prices which cause inflation. Concerns over the impact of these sanctions is expected to impact liquidity. Surging commodity prices threaten more inflation, which may restrain FED from tightening aggressively against earlier expectation by the markets.

Domestically, bonds were supported by month-end demand, led by offshore investors. MGS curve was little changed MoM as Ringgit bonds showed relative calm contrasting the volatile UST which has been torn between inflation and geopolitical risks. 10Y MGS yield end at 3.668% on cautious market driven by geopolitical tensions in Ukraine and outlook on FED hikes in March. Overall benchmark yields were mixed, with the 3Y MGS yield fell 13bps mom to 2.71%, 5Y MGS at 3.29% (+5bps), 7Y MGS at 3.59% (+9bps), 10Y MGS at 3.67% (+1bp), 15Y MGS at 4.05% (+3bps), 20Y MGS at 4.22% (-4bps) and 30Y MGS at 4.4% (+7bps).

Three auctions conducted in February:

I. 5-yr Reopening of MGII 09/27, RM5.0bn

II. 30-yr Reopening of MGS 06/50, RM5.0bn (RM2.5bn auction + RM2.5bn private placement)

III. 7-yr Reopening of MGII 10/28, RM4.5bn

Malaysia bonds offer the best profile to seek cover

February flows showed that demand for bonds held up well despite the heighted volatility in UST. Geopolitical risks around Russia-Ukraine could become as important as the upcoming Fed hike cycle in driving Asian rates and the impact is via swings in global risk sentiments. While Asia has little economic and financial exposure to Russia and Ukraine, heightened risk aversion could see bond investors cut risks by indiscriminately selling emerging market (EM) bonds.

So far, risk sentiments still seem to be holding up. Still, we cannot discount the scenario where sentiments sharply deteriorate with more punitive sanctions or more countries entering the military conflict. A swift de-escalation appears unlikely, with geopolitical tensions likely to rise steadily in the near term. A prolonged period of heightened uncertainty around the likely endgame would drive higher risk aversion and greater risk premiums across Asia rates and bonds.

In the near term, for Asia bond investors, we think that Malaysia government bonds offer the best profile to ride out the Russia-Ukraine conflict. At present, risk-off sentiment and sky-rocketing commodity prices sparked by Russia-Ukraine tensions and sanctions are initiating some asset reallocation into commodity producing countries including Malaysia. As the only Asian economy with positive oil and gas trade balances, Malaysia would marginally benefit from higher oil prices via higher terms of trade. Though foreign ownership of Malaysia MGS/MGII is high (~26%), a significant portion of foreign holdings is held by foreign central banks and foreign governments, which is expected to be more sticky and less susceptible to outflows around risk aversion.

Domestic conditions remain conducive for Ringgit bonds as BNM is not expected to raise interest rates aggressively like the Fed in the absence of demand-pull inflation risk in Malaysia while the economy is expected to rebound on sustained reopening. We think that Malaysia government bond would hold up relatively well and given Malaysia’s positive oil and gas trade balance, MGS would likely be able to ride out this period of volatility.

Source: BIMB Securities Research - 9 Mar 2022