OVERVIEW

● Malaysia’s foreign reserves contracted for the second month by USD3.8b or 3.5% to USD104.7b in June amid further fund outflows from the emerging markets following Fed’s latest move to hike interest rates and its indication of further hawkish direction with additional two more rate hikes for 2018. Shares slumped across emerging markets with Malaysia suffering one of the largest pull-out as domestic news flow aggravated investors’ negative sentiments while global trade uncertainties lingered further. The month’s reserve position remained sufficient to finance 7.5 months of retained imports and is 1.1 times the external debt.

● Ringgit’s depreciation for the third month by 0.89% (May average: -1.98%) in June boosted the Ringgit value of reserves by 1.1% to RM423.4b. The Ringgit average depreciated by 0.6% in 2Q18, eroding the 5.7% gains of 1Q18.

● Portfolio capital flows experienced a worse than expected decline in June as foreign equity outflow remained elevated at RM4.9b. Trade tension uncertainties, concerns on the fiscal impact of the new government’s policy move (zero-rate GST, review of megaprojects, etc) as well as rising US interest rates continued to be the forefront of investors’ concerns during the month. In fact, we continue to expect investors to stay side-lined or defensive during this period of time as they await the release of the government’s 100-day progress and their First Budget.

● Despite some continued short term selling pressure, we expect investor sentiment to potentially improve in 3Q18 as investors could have already priced in risks of steeper global interest rates in 2Q18. Additionally, we expect sentiments to gradually improve as the government completes its 100 days of administration and domestic news flow improves. In particular, we expect the local bond market to sustain capital flows for the rest of 2018. The average yield spread between the benchmark US 10-year Treasury yield and the local 10-year MGS bond yield appears to remain healthy as it widened further to 130 basis points in June from 120 basis points the preceding month.

● While neighbouring Asean economies including Indonesia and Philippines have begun to gradually lift rates, we expect BNM to continue to leave the overnight policy rate unchanged as it prioritises growth sustainability at this point of time. Global trade tensions have escalated with an additional 25.0% tariff imposed on a total of USD34.0b China’s goods and China retaliates with a comparable tariffs of its own. This would particularly hit the emerging Asean exportdependent economies growth. Along with easing inflationary pressure, we expect BNM would leave the overnight policy rate unchanged at 3.25% for 2018.

Source: Kenanga Research - 9 Jul 2018