● Foreign investors turned net buyers of Malaysia’s debt securities in January (RM0.5b; Dec: -RM0.9b), for the first time in five months

- Total foreign debt holdings increased (RM247.3b; Dec: RM246.8b), but its share to total outstanding debt edged lower (13.1%; Dec: 13.2%) amid a month of sizeable auctions.

- Foreign demand for Malaysian bonds improved, especially early in January, as global sentiment turned risk-on amid expectations of a less hawkish US Fed. Then again, demand likely abated towards the end of the month following BNM’s surprise move to pause hikes and as US economic data suggested that the Fed could remain hawkish for longer.

● The inflow was driven by a greater increase in holdings of Government Investment Issues (GII) and a smaller outflow of Malaysian Islamic Treasury Bills (MITB), which outpaced a smaller increase in Malaysian Government Securities (MGS)

- GII (RM1.4b; Dec: RM0.5b): foreign holdings share increased to a 5-month high (8.7%; Dec: 8.5%).

- MITB (-RM1.7b; Dec: -RM3.2b): foreign holdings share plunged to a 2-year low (8.8%; Dec: 17.7%).

- MGS (RM1.3b; Dec: RM2.2b): foreign holdings share edged lower (34.5%; Dec: 34.6%).

● For the equity market, foreign investors remained net sellers for the fifth consecutive month in January

- Foreign outflows moderated to a 2-month low (-RM0.3b; Dec: -RM1.4b), as global risk-aversion eased.

● Overall, the capital market recorded its first net inflow in five months (RM0.2b; Dec: -RM2.2b)

● The debt market may continue to receive modest foreign inflows in the near-term

- The 10-year US Treasury average yield fell by 12 bps to 3.51% in January, whilst the 10-year MGS average yield plunged 18 bps to 3.87%, narrowing the average yield spread to its lowest since April 2010 (35 bps; Dec: 41 bps).

- Despite the return of foreign demand in January, we reckon foreign inflows into the debt market will remain relatively modest given that the US Fed and other major central banks are still tightening. Furthermore, there is growing risk that the Fed will raise rates further than markets expect and bring the terminal rate beyond 5.0%, as jobs figures remain very strong and core inflation could still prove sticky. With that said, we still expect foreign inflows to chart a more stable recovery from 2Q23 onwards, after most major central banks likely complete their tightening cycles. Malaysian bonds could also benefit from positive sentiment surrounding China’s reopening, which has already led to a strong return of portfolio inflows into the world’s second largest economy.

- Following BNM’s surprise pause we think the central bank will hold the OPR at 2.75% for the rest of the year, given that headline inflation has peaked and the global economic outlook remains uncertain.

Source: Kenanga Research - 14 Feb 2023