OVERVIEW

● Foreign holders of Malaysian bonds turned net sellers in August as total foreign holdings fell by RM1.8b after a short lived increase of RM4.0b in July. Fear of the spread of the emerging market currency crisis as well as the strong pull towards US dollar assets backed by the strong US economy and the prospect of two more rate hikes this year were the prime reasons for the selloff.

● The net decline were equally contributed by the Malaysian Government Securities (MGS), Government Investment Issues (GII) and short-dated bonds at about RM0.6b each. As a result, foreign investors’ share of total government debt is now at 13.7%, while its share of MGS shrank to 40.0% its lowest in six years.

● Dissonance between the White House and the Federal Reserve as President Donald Trump criticised the Fed pace of rate hikes cause longer-dated US government bond yields to move higher, occasionally steepening the yield curve. Nonetheless the US 10-year Treasury note average yield remained unchanged at 2.87% in August. However, the benchmark 10-year MGS average yield fell by 5 basis points (bps) to 4.04% in August as demand for MGS improved. Hence, the MGS-US Treasury average yield spread narrowed to 117 bps from 122 bps in July.

● We remain cautiously confident that Malaysia’s economic fundamentals are relatively strong and stable as reflected in the better-than-expected July trade performance in spite of the escalating trade-spat between US and China. So far, Malaysia seems to be less affected by the concerns of an emerging market contagion compared to its EM peers. Case in point, the 10-year MGS yield gained 10.2 bps to 4.17% as at 6 Sep since end of July compared with much higher gains for example +244 bps for Turkey’s benchmark bond yield (20.0%), as well as Indonesia (+77.9 bps to 8.50%), India (+28.3% to 8.06%) and China (+14.6 bps to 3.63%). The higher gains in yield reflects investors’ negative sentiment and the magnitude of the bond sell off.

● The global economic slowdown remains key significant risk as President Trump’s tax reforms and fiscal expansion could lead to inflationary pressure that produces faster increase in US interest rates subsequently putting the brakes on growth. China on the other hand has on-going efforts to rebalance its economy via financial and social reforms as well as focusing on domestic consumption led-growth. However, the ensuing trade war could jeopardise or at best weaken these efforts. Though we still think that the ringgit would still be susceptible to further devaluation we expect BNM to leave the Overnight Policy Rate (OPR) unchanged at 3.25% for this year to support the economy.

Source: Kenanga Research - 12 Sept 2018