Yesterday BNM raised the OPR by +25bps for the fourth time this year to 2.75%. We believe the market can stomach higher rates, seeing that KLCI’s earnings yield spread to MGS10 is still decent at +0.5SD above 5Y mean. However, a widening FFR-OPR spread (rose from +63bps to +113bps) is broadly negative for the KLCI (-58% correlation), not to mention possible further weakness in ringgit. Sectorial winners from the OPR hike are banks while losers are REITs and property. Maintain end-2022 KLCI target at 1,540 pending the outcome of GE15 on 19 Nov.

NEWSBREAK

Yesterday, BNM raised the OPR by +25bps to 2.75%. This was a surprise to us as we expected BNM to pause in Nov before resuming with 2x25bps hike in 1H23.

HLIB’s VIEW

Narrowing earnings yield spread but still decent. While OPR hikes (or its expectations) generally lead to higher bond yields, we note that the current spread between the KLCI’s earnings yield and MGS10 is still relatively decent at 2.49% (+0.5SD above 5Y mean). Intuitively, this spread is a measurement of the relative attractiveness of investing in Malaysian equities vs the country’s risk free rate – a narrower spread makes equities relatively less attractive, vice versa. Assuming our 2x25bps OPR hike expectation pans out in 1H23, this would narrow the hypothetical spread to 1.99% (-0.3SD below 5Y mean) – not exactly attractive, but still palatable.

Winners and losers. The banking sector (which we are OVERWEIGHT on) is a near term winner from an OPR upcycle as NIM is expected to widen – our banking analyst estimates that every +25bps OPR hike would bump up sector NIM by 5-6bps and earnings forecast by 4-5% (big gainers are Alliance and BIMB, while small gainers are Affin and Public Bank). Sectors on the losing end are likely to be REITs (narrowed spread between divvy yields and MGS10) and property (our property analyst estimates that a 25/50/75bps rate hike would increase monthly mortgage instalments by 3.2%/6.5%/9.9%).

Double whammy from widening FFR-OPR spread. With yesterday’s +25bps OPR hike and +75bps for FFR earlier the same day, the FFR-OPR spread has widened from +63bps to +113bps. With expectations for the Fed to raise the FFR by +50bps in Dec, the spread could hit +163bps by year-end. This could be negative for the local bourse as there is a -58% correlation between the FFR-OPR spread and KLCI – times of widening spread has seen market weakness (see Figure #2). Not to mention continued FFR-OPR spread widening could lead to continued ringgit weakness. We expect USD-MYR to average 4.44 in 2022 and end the year at 4.80.

KLCI target at 1,540. With the KLCI having rebounded as much as +6.3% (up to 31 Oct) from its YTD low in mid-Oct, we envisage some weakness in Nov as risk aversion sets in moving closer to the national polls (19 Nov). Nevertheless, the market should see a positive Dec given the traditional window dressing effect – post GFC, the KLCI registered positive Dec returns in 11 out of the past 12 years (92% hit rate). Pending the outcome of GE15, we keep our end-2022 KLCI target unchanged at 1,540 (15.5x mid-CY23 PE) and 2023 at 1,590 (15.5x CY23 PE).

Source: Hong Leong Investment Bank Research - 4 Nov 2022