OVERVIEW

• Sustained net foreign inflows. Net foreign holdings of Malaysian debt securities rose RM2.7b in December (Nov: RM6.7b). The inflow was largely driven by MGS (RM4.1b) and GII (RM0.6b). Consequently, foreign holdings of MGS rose to 11-month high of 45.1% in December.
• Looming risks on bonds. However, the domestic debt market faces impending risk of expected Fed monetary tightening, downward price movements in crude oil and geopolitical tensions in the region.
• Sound fundamentals to support fund flows. Nevertheless, we expect a sustainable growth momentum, a sizeable current account surplus, benign inflation outlook, prudent fiscal position together with a strengthening ringgit to attract bond funds into the domestic debt market this year.
• Monetary tightening on the radar. In view of the improving financial conditions and the economy combined with possible BNM’s move to neutralise the impact of the Fed rate hike on the capital market, we expect BNM to raise the OPR by 25 basis points as early as in the 1Q18.

Sustained net foreign inflows. Malaysian debt securities saw a second month of net foreign buying activities in December. Foreigners purchased a net RM2.7b of Malaysian debt securities in December, though it was lower than the RM6.7b recorded in the preceding month. Consequently, total share of foreign holdings in Malaysian debt securities edged up to 16.0% from 15.9% in November. Despite the RM6.6b net foreign inflows recorded in 4Q17, the Malaysian debt market registered a net foreign capital outflow of RM8.0b for the whole of 2017, mainly due to the large net outflows of RM37.4b in 1Q17.

Strong MGS inflows supported holdings. The overall inflows were mainly driven by a solid MGS net inflows of RM4.1b (Nov: +RM7.1b) and Government Investment Issues (GII) of RM0.6b (Nov: -RM1.9b). As a result, foreign holdings of MGS rose to 45.1%, the highest in eleven months. Nevertheless, foreign holdings in Bank Negara Monetary Note (BNM) declined RM1.0b in part due to some scheduled redemption activity for the month. The positive fund flows data in December suggests that foreign investors appear to still favor Malaysian financial assets triggering an appreciation of the ringgit which in turn attracts more foreign investors to supplement their capital gain.

In line with higher reserves. Concurrently, foreign funds returned to local equity market in December with a net purchase of RM0.96b. Subsequently, the favorable foreign fund flows seen in the equity and debt market helped to lift the foreign external reserves to USD102.4b in December, the highest level since June 2015. The continued expansion in external reserves along with improving financial conditions will further boost investors’ confidence and spur higher demand for Malaysia’s financial assets in the longer term.

Looming risks for bonds market. Although we largely see the Malaysian capital market to be less susceptible now to adverse international fund flows in the face of firmer investment sentiments and improving financial conditions, we remain wary of looming risks. The expected US fed funds rate hikes together with the increasingly tighter monetary environment among regional economies present the largest risks to the domestic debt market. Other impending risks include a sharp downward trend in crude oil as well as geopolitical tensions in the region that could trigger a sell-off in emerging market assets including Malaysia.

Fundamentals to dominate fund flows. Overall, we maintain an optimistic outlook for the prospects of foreign fund flows into the domestic debt market, supported by sound economic fundamentals. We see solid current account surplus, benign inflation outlook along with prudent fiscal position resulting from government fiscal consolidation initiative to underpin healthy capital inflows in the domestic debt market this year. As such, we expect the ringgit to remain on a strong footing and gradually appreciate against other major currencies apart from the US dollar such as British pound, Sing dollar, Aussie dollar and the Japanese yen. Nevertheless, we may also see a more volatile ringgit mainly affected courtesy of at least three rate hikes by the US Fed this year. Hence, we may see the USDMYR pair trading in a wider range between 3.95 and 4.10 in the 1Q18.

Monetary tightening on the radar. Despite the recent rise in US Treasury yield fuelled by expectation of Fed Funds rate hike, the current Malaysian securities are still maintaining a comfortable yield spread over its US Treasury counterpart, providing an attractive risk and return profile to investors. Nonetheless, we believe BNM might seek to neutralise the impact

of the Fed rate hike on the capital market. This, coupled with the improving financial conditions, might prompt BNM to tighten its monetary policy and raise the OPR by 25 basis points as early as in the 1Q18.

Source: Kenanga Research - 10 Jan 2018