OVERVIEW

• Foreigners turned net sellers in February, leading to RM4.6b of outflows. Bonds selloff was across the board from both long term and short term bonds as rising global yields undermine demand for Asian bonds.
• …equities also saw foreign funds exit. February’s capital market saw a large foreign fund outflows of RM1.1b in February (Jan: +RM3.4b) due to a market correction and rising uncertainties on Trump’s administration policies.
• OPR hike elevates MGS yields. BNM’s January decision to raise the Overnight Policy Rate (OPR) by 25 basis points has elevated the MGS benchmark 10-year bond yields. On the back of the elevated MGS yields, the yield gap remains favourable at 113 basis points, favouring MGS. We see renewed interest in the local bond market and foreigners returning as net buyers following the strong economic fundamentals of the economy.
• Stable fund flows seen. We retain our view on the outlook for overall fund flows and do not foresee significant capital flight at the moment. However, we are cautious on the risk of global trade war following Trump’s recent sanctions and its possible adverse effect on the volatility of the global capital markets.

Foreigners turned net sellers. Investors shun away from Malaysia’s debt market last month, leading to RM4.6b of outflows in February (Jan: +RM4.5b). The bond market selloff transpired to reduced foreign holdings in the Malaysian debt securities, which consequently fell to the lowest in four months, at 15.7% (Jan: 16.1%). The selloff was the first following past three months of net inflow into the local debt market.

Across-the-board selloff. February’s decline was across both short term and long term instruments. Long term bonds saw interest waned, recording a net outflow of RM3.1b (Jan: +RM4.2b) from the Malaysian Government Securities (MGS) and RM0.5b (Jan: +RM0.4b) from the Government Investment Issues (GII). As a result, foreign holdings of MGS and GII were reduced to 45.4% (Jan: 45.7%) and 6.7% (Jan: 7.0%) respectively. Short term instruments similarly saw foreign buying slowed during the month as net foreigners bought a mere RM0.03b of Malaysian Treasury Bills (Jan: RM0.4b). The drop in fund flows to both the short term and long term instruments was due to rising global yields and volatility undermining demand for Asian bonds, including that of Malaysia. Yields rose at a faster pace in the developed markets including US, leading to higher demand for developed markets’ bonds relative to Malaysian bonds.

MGS benchmark 10-year bond yield rose to an average 4.00% in February from 3.90% in January. However, the rise in the MGS yields were at a lower rate compared to the US bond yields which rose to 2.86% in February from 2.58% in January.

…equities also saw foreign funds exit. Market correction, fear of Fed’s rate hike and threat of Trump’s administration’s policies led foreigners to exit the local equities market in February. The stock market saw a large outflow of foreign fund amounting to RM1.1b (Jan: +RM3.4b). The outflow weighed on the local external reserves, resulting in a sharply lower net increase of just USD58.4m from a hefty gain of USD1.2b in January.

OPR hike elevates MGS yields. Despite the fund outflow from the bond market during the month, BNM’s January decision to raise the Overnight Policy Rate (OPR) by 25 basis points has elevated the MGS 10-year bond yields. On the back of the elevated MGS yields, the yield gap remains favourable at 113 basis points. Hence, we see renewed interest in the local bond market moving forward and foreigners to return as net buyers. We expect the strong economic fundamentals of the economy, supported by solid current account surplus, benign inflation outlook and rebound in global oil prices to draw foreign funds’ return. We also maintain our view that there is still room for another 25bp of OPR hike, raising the prospects for local bonds.

Stable fund flows seen. Federal Reserve Chairman Jerome Powell repeated the FOMC’s January message, saying “further gradual increases’’ in the Fed’s policy rate “will best promote’’ the central bank’s objectives of maximum employment and stable prices. Along with the expectation for inflation to move up, Powell’s message reiterates a hawkish Fed direction in 2018. We retain our view on the outlook for overall fund flows and do not foresee significant capital flight at the moment. However, we are cautious on the risk of global trade war following Trump’s recent imposition of higher tariffs and its resulting effect on the volatility of the global capital markets. We expect the USDMYR pair to hover between 3.80-4.00 in the short term before ending at a more stable footing of 3.90 by year end.

Source: Kenanga Research - 9 Mar 2018