● Foreign investors remained net buyers of Malaysia’s debt securities for the fifth consecutive month in May (RM3.0b; Apr: RM1.5b), rising to a two-month high

- Total foreign debt holdings increased (RM262.7b; Apr: RM259.7b), but its share to total outstanding debt edged lower (13.4%; Apr: 13.5%).

- Foreign demand for domestic bonds remained resilient despite broad global risk aversion in May, amid concerns over the US debt ceiling and US Fed hawkishness. Local bonds may have been supported by relatively high yield differentials against developed market bonds, but spreads narrowed considerably towards the end of the month as developed market yields surged.

● The greater inflow was driven by an increase in holdings of Malaysian Government Securities (MGS), which outweighed a decrease in holdings of Government Investment Issues (GII) and Malaysian Treasury Bills (MTB)

- MGS (RM3.8b; Apr: -RM1.7b): foreign holdings share of total outstanding bonds edged higher (36.0%; Apr: 35.9%).

- GII (-RM0.8b; Apr: RM1.6b): foreign holdings share remained unchanged (9.2%; Apr: 9.2%).

- MTB (-RM0.4b; Apr: RM1.2b): foreign holdings share fell to a three-year low (28.3%; Apr: 32.3%).

● For the equity market, foreign investors remained net sellers for the ninth straight month in May

- Foreign outflows increased (-RM0.7b; Apr: -RM0.3b), particularly towards the end of the month.

● Overall, the capital market registered a greater net inflow of RM2.3b (Apr: RM1.3b) solely due to bond flows

● Foreign inflows into the bond market to remain steady in 2H23 should the Fed complete its tightening cycle

- The 10-year US Treasury average yield increased by 12 bps to 3.59% in May, whilst the 10-year MGS average yield fell 9 bps to 3.72%, considerably narrowing the average yield spread (13 bps; Apr: 34 bps).

- Foreign demand for domestic bonds may be slightly subdued in June, given the relatively low yield spreads against developed market bonds, compared to more attractive regional alternatives. Nonetheless, foreign inflows may pick up in 2H23 as global risk aversion eases following an agreement on the US debt ceiling, and should the Fed pause rate hikes at this week’s meeting (June 13 – 14); we expect the Fed to keep rates unchanged and to signal the end of its tightening cycle. However, given relatively hawkish comments by some Fed officials and signs of a resilient US labour market, we now expect the Fed to only begin cutting rates in 1Q24. That said, there is notable risk of foreign outflows should the Fed continue raising rates instead and if China’s recovery continues to lose momentum.

- We reckon BNM will keep the OPR unchanged for the rest of the year, given our expectations that core and headline inflation will trend lower in the coming months. We also believe that the neutral level of 3.00% strikes a good balance between supporting growth and curbing inflation.

Source: Kenanga Research - 12 Jun 2023