OVERVIEW

• March foreign bond selloff highest ever. Foreign ownership of Malaysia’s government bonds in March fell for the fifth straight month at a record RM27.5b. The redemption was mainly driven by the Malaysian Government Securities (MGS) which plunged by RM23.0b, followed by BNM Bills (-RM3.4b) and Government Investment Issues (-RM0.6b).
• But reserves gain, ringgit stabilised and stock market up. Despite the large bond selloff, the foreign exchange reserves gained slightly, the USD/MYR have stabilised, and the stock market gained by about 4.0% since the beginning of the year.
• A switch in portfolio investments. Judging from the current trend we believe that total net portfolio flow could have turned positive in the 1Q17, suggesting the possibility that some foreign funds may have switched their investment preference in favour of equities over bonds.
• Bond selling expected to abate. We expect the selloff in government securities to subside in the coming months on the back of local institutional support and as the US Fed’s gradually tone down its hawkish slant.

A record decline. The drop in foreign holdings of government issued bonds have been relentless and March have been the worst up till now. Total foreign ownership of government bonds fell sharply by a record RM27.5b in March (RM6.6b in Feb). This marks its fifth straight month of decline outpacing the previous record slump of RM18.9b in November last year following the result of the US Presidential election.

MGS fell the hardest. The outflows were mainly driven by a record decline in MGS of RM23.0b (Feb: -RM7.4b), followed by BNM Bills (RM3.4b) and GII (RM0.6b). This is inclusive of the RM10.5b of MGS redemption in March. As a result, foreign holdings of MGS dipped to 38.5%, the lowest in almost six years or since April 2012.

Heightened risk. Meanwhile, the drop in foreign ownership of GII, including government sukuks, has gotten bigger, declining by RM0.6b from just RM0.1b in February. As a result, the share of foreign holdings dipped further to 7.9% from 8.3%, its lowest in a year. However, it’s worth noting that in the last five months the inflows have been relatively better for GIIs than MGS (Graph 1) perhaps partly due to investors’ preference for short dated government-backed papers in view of heightened external risk and uncertainty.

Scaling back on shorter dates. However, foreigners suddenly appear to be more averse to hold short tenor securities. This is reflected in a large drop of BNM Bills and Notes in March, losing RM3.4b, a large chunk of its total of RM8.9b, after five straight months of increase. As a result, its foreign share drastically shrank to just 57.7% from 92.8% in February, a level last seen in mid-2012. In the same period, the stock market was on a bullish trend, the ringgit remained steady at low 3.00 relative to the USD and the forex reserves were near its highs (US$140.0b).

Big sucking sound. Overall, total foreign holdings of government securities fell by RM27.5b (Feb: -RM6.6b). Its share of total government bonds has been reduced to 24.9% from 29.3% in February. The cumulative outflow from government bonds since November last year has reached a staggering RM61.5b. To put this in perspective, outflows during the taper tantrum episode in June to August 2013 totaled only RM28.0b while the highest annual inflow into government bonds was just RM52.6b in 2010.

But reserves holding up as ringgit stabilises. Meanwhile, despite the record bond sell off by foreigners, Malaysia’s foreign reserves inched up US$0.4b to US$95.4b at endMarch. This is sufficient to finance 8.3 months of retained imports and 1.1 times of short-term external debt. Due to quarterly revaluation, in ringgit terms, foreign reserves fell RM4.1b at end-March to RM422.2b from the preceding month. During the 1Q17, the ringgit strengthened by about 1.5% against the US dollar. Though it is still weaker by about 9.0-10.0% from a year ago, it has been relatively stable and hovering around 4.41-4.45 since mid-March. The relative stability of the ringgit is partly due to Financial Markets Committee’s effort to effectively curb the trading of ringgit non-deliverable forwards (NDF) since November last year. It also enforced the conversion of a bigger portion of exporters’ earnings (75% share) into MYR. This has somewhat increased the supply of dollars which helps to cushion further depletion of foreign reserves.

Equity inflows on a roll. At the same time the Malaysian equity market enjoyed the global resurgence of capital inflows into the emerging markets thanks to higher exports earnings and to a certain extent the impact of President Trump’s reflation policy. The net inflows of foreign funds into domestic equities reached RM5.7b, the highest since 1Q13 (+RM9.0b). In March alone, foreigners bought RM4.4b of domestic equities. prior to net inflows of RM1.0b and RM0.4b in February and January respectively. At the same time the FBMKLCI gained 4.1% or 68.55 points to 1,740.09 in the 1Q17.

Investment switch. Though we may yet know for certain how large was the actual net flow of portfolio investments (equity, bonds and other financial instruments), judging from the current trend, we believe it could have turned positive in the 1Q17. This suggests the possibility that some foreign funds may have switched their investment preference in favour of equities over bonds instead of fully repatriating their funds. Based on the capital account of the balance of payments, net portfolio investment registered a deficit of RM22.3b and RM10.6b in 4Q16 and 3Q16 respectively. A slightly positive gain in external reserve in the 1Q17 is indicative that the capital account in the balance of payments would turn out positive which often times is attributed to a net gain in portfolio investments.

Remains vulnerable to external risk. While the ringgit continued to see some upside against the US dollar, we remain cautious on the relative weakness of the ringgit. With at least two more indicative rate hikes by the US Fed, it could weigh down on the MYR strength and heightens the vulnerability of foreign holdings of domestic financial assets. But there are signs that the US Fed is gradually toning down its hawkish slant. This may help to taper down risk of large capital outflows from the emerging economies. Nevertheless, we maintain our view that the USDMYR would be range bound in the short to medium term between 4.40-4.50 while our year-end forecast is 4.35.

Bond selling to subside. The current sell down of portfolio capital in the bond category is expected to continue given the prospect of two more rate hikes by the US Fed on top of the remaining bond maturities amounting to about RM67.0b. However, we expect the worse is over and the selloff would subside largely supported by the buying strength of local institutional funds led by the Employees Provident Fund as it raises its holdings of government securities. Last year it invested 23.8% of its total asset size of RM703.0b or RM167.0b in Federal government securities. As it had already increased its purchase of Federal Government securities by 2.5% to RM4.1b in January presumably to absorb the foreign selloff, we will not be surprised that it would surpass last year’s total investments in govies. Perhaps a reversal in the equity market would also pull some of the money back to the safety of government bonds.

Source: Kenanga Research - 11 Apr 2017