OVERVIEW

● Malaysia’s foreign reserves continue its downtrend for the third consecutive month declining by a marginal USD0.2b or 0.2% to USD104.5b as at July 31. The month’s reserves position remains adequate to finance 7.5 months of retained imports and is 1.1 time the external debt. Latest data from Bank Negara Malaysia (BNM) showed that the level of reserves remains healthy despite the growing uncertainty in the global economy.

● Ringgit depreciated for the third straight month, losing 1.3% MoM in July (June: -1.0%), while the value of reserves in Ringgit terms fell marginally by 0.1% to RM422.8b. We believe the Ringgit remains undervalued as the economic fundamentals remains intact backed by sustained strong domestic demand, low inflation and unemployment rate as well as the current account maintaining a surplus reflective of excess savings over investment.

● Portfolio capital flows saw a slow decline in July amid US-China trade tension and the prospect of two more rate hikes by the US Federal Reserve by year end as net foreign equity outflow slowed to RM1.7b compared to RM4.9b in outflows in June. While we have seen shares slumped and currencies depreciated across emerging markets including Malaysia in the 2Q18, we expect foreign capital outflow for the rest of the year to taper barring the unforeseen.

● Despite some continued short term selling pressure in the 2Q18 due to domestic and global factors, we expect investor sentiment to improve in 2H18 as the new government completes its first 100 days and fulfils all if not most of its ten pre-election promises without any major hiccups.

● Meanwhile, we expect the local bond market to stabilise and capital flows to turn positive in the 2H18. The average yield spread between the benchmark 10-year US Treasury yield and the local 10-year MGS bond yield declined to 122 basis points in July from 130 basis points the preceding month. The average yield of 10-year US Treasury in July was the lowest in three months amidst the escalation of trade war between the US and China.

● Despite the continued outflow of capital and the weak ringgit we expect BNM to maintain the overnight policy rate at 3.25% for the year. As global trade tensions have further escalated, the impact on the capital market and the economy is expected to remain uncertain. Hence, the monetary policy is biased towards easing as BNM’s priority would be to support growth and price stability.

Source: Kenanga Research - 8 Aug 2018