OVERVIEW

? Foreigners were net sellers of Malaysian debt securities for the second month, a staggering RM12.9b in May (Apr: –RM4.7b), the biggest drop in 14 months or since the record RM26.2b fall in March 2017. The outflow slashed foreign holdings share in Malaysian debt securities to the lowest in eight years (since June 2010) to 14.2% (April: 15.2%). Investor sentiments were rattled by the unprecedented outcome of the 14th General Election and by the subsequent news flow on the Pakatan Harapan government’s policy decisions. External factors were also less encouraging as the US growth indicators point north, suggesting a more hawkish US Fed. Along with rising global trade tensions, demand for emerging market’s bonds as a whole weakened in May.

? The month’s sell-off was broad-based across both short-dated and long-dated securities. Short-dated securities registered the largest outflow in 14 months of RM2.3b (April: -RM638m). The 26.1% decline (April: -6.8%) in foreign fund flows led to foreign holdings of total shortdated Malaysian bonds sliding to 53.9% (April: 60.4%). Similarly, foreign holdings of long-dated securities (MGS + GII) recorded the largest outflow in 14 months of RM9.8b. As a result, its share slid to 25.9% (April: 27.7%) of total longdated debt, a 14-month low. Consequently, the average local benchmark 10-year MGS bond yields surged to 4.17% in May (April: 4.04%). Meanwhile, the average yield gap between the benchmark US 10-year Treasury yields and the local 10-year MGS bond yields widened to 120 basis points from 116 basis points the preceding month.

? We expect continued selling pressure in the coming months following rising concerns that credit rating agencies would put Malaysia on ratings watch due to the new government’s decision to cancel large scale infrastructure projects. The implementation of fuel subsidies and the removal of the Goods and Services Tax which could weigh on the government’s ability to meet its fiscal target is adding pressure to sentiments. Additionally, the sudden resignation of Bank Negara Malaysia’s governor and the change in several government-linked corporate heads is also expected to add uncertainty to the domestic bond market. Meanwhile, rising expectations of US Fed rate hike is expected to weigh on regional bond markets. The average 10-year Indonesian bond yield jumped to 7.18% in May (April: 6.70%) while India’s average 10-year bond yield has climbed to 7.78% (April: 7.51%).

? On a bright note, the issue of the new benchmark 20-year MGS successfully drew a good demand, signalling that investors remain confident of the long-term outlook of the local bond market. Additionally, we expect a gradual relaxation of the forex administration rules implemented during the former BNM governor’s time to lure foreign capital. Hence, we retain our view for the current capital flight to continue in 2H18 before capital flows stabilises. As such, we remain optimistic of the long-term capital flow outlook which would provide BNM the flexibility to retain its Overnight Policy Rate at 3.25% to accommodate growth and meet its 5.5-6.0% economic growth target for this year.

Source: Kenanga Research - 11 Jun 2018