BOND yields in Malaysia could continue to rise amid weak domestic conditions as global crude oil prices and the ringgit persist in their downtrend.

Yields on 10-year Malaysian Government Securities (MGS) saw an uptick as the ringgit plummeted over 13% from its peak of 3.1463 against the US dollar in August 2014. Ten-year MGS yields rose as high as 4.26% on Dec 16, 2014, from 3.85% at end-October. However, they flattened out to 3.98% last Wednesday (see table).

The earlier uptick in yields had largely been attributed to foreign outflows. In November, foreign holdings in MGS continued to ease to RM145.2 billion, or 44.5% of the total outstanding, from RM146.7 billion (45.9%) the month before.  

But as domestic purchasers move to fill in the gaps in the market, flattening yields indicate that the market is not expecting a high interest rate environment, according to Charanjeev Singh, managing director of New Paradigm Capital Markets Sdn Bhd.

“Right now, everyone is unsettled by crude oil prices, and they have priced that in [MGS yields]. Everybody is expecting [low crude oil prices] to affect the economy and interest rates are already reflecting that,” he tells The Edge.

He expects yields to stabilise by the second half of the year, depending on how crude oil prices trend.

Market observers and economists have expressed concern over Malaysia’s ability to meet its 3% fiscal deficit target for 2015 on the back of falling Brent crude oil prices, which have tumbled more than 60% to US$46 (RM163) per barrel from its high of US$115 on June 19 last year.

Oil revenue made up 31% of total government revenues of RM220.4 billion in 2013. The government budgets its income based on the assumption that oil prices will trade between US$100 and US$110, meaning that the value of expected oil revenue has more than halved since August 2014.

“In 2015, we expect the MGS yield curve to steepen bearishly due to a possible deterioration in the government’s fiscal position, as well as growing inflation expectation,” says Malaysian Rating Corp Bhd (MARC) chief economist Nor Zahidi Alias in a Jan 9 note. Corporate bond yields are expected to rise in tandem.
At the same time, the ringgit is showing no signs of halting its downward momentum, closing at 3.5587 last Friday.

“The sharp ringgit depreciation has created some panic in the market, but valuations have become increasingly attractive,” RHB Research regional head of fixed income and currency research Ray Choy tells The Edge.

“There have been outflows in expectation of higher interest rates in the US, while there has also been a slew of unexpected factors dampening sentiment on the public relations front. In the long term, Malaysia will see structural inflows from foreign investors, and this should remain so, as Malaysia’s yields are still quite attractive compared with those of developed markets,” he says.

But Choy also says the recent foreign sell-down of the last few months has been behaviourally driven, and this is usually not persistent when it is not well-justified by fundamentals. He says Malaysia’s debt sustainability is manageable as its debt-to-GDP ratio has improved since 2010, and that monetary conditions remain accommodative.

“On one hand, potentially tighter monetary policy in the US could cause outflows from Malaysia and other emerging markets but, on the other hand, Japan and Europe are attractive funding currencies for re-investment in Malaysia and other investment-grade economies in Asia,” Choy says.

Given that Japan and Europe are facing ongoing risks of deflation and should continue to implement monetary easing, fixed-income markets may turn more sanguine given the already sharp pricing in of negative trends in recent months, says Choy.

Some observers believe that short-term fears aside, investors remain focused on Malaysia’s resilient economic fundamentals.

RAM Holdings Bhd head of research Kristina Fong believes that investor sentiment in 2015 will mimic what happened when the US Federal Reserve began to taper its quantitative easing programme and raised interest rates for the first time since the global financial crisis.

“Thus, there may be some normalisation of investor portfolios, but no major cause for excessive or sudden fund pull-outs,” Fong tells The Edge.

RAM forecasts the ringgit to average 3.45 against the greenback this year, rebounding on resilient economic fundamentals. But the ringgit could fall as low as 3.65 on uncertainties over US monetary policy and domestic headwinds facing Malaysia’s fiscal and current accounts.

RHB’s Choy expects the ringgit’s weakness to weigh on the bond market in the near term. “However, a point appears to be close, when both bond yields and a cheap ringgit [can] justify their positions again,” he says.

Bond issuances this year will be heavily supplied by government-guaranteed sectors such as utilities, infrastructure and banking bonds, market observers say.

RHB expects corporate bond issuance to total around RM80 billion in 2015, while government bond issuance could reach between RM92 billion and RM95 billion.
MGS issuance totalled RM84.5 billion last year, while corporate bonds were at RM85.9 billion.

RAM expects corporate bond issuance to total between RM90 billion and RM95 billion in 2015, supported by infrastructure development, continued capital augmentation by financial institutions and construction activities. It forecasts the issuance of MGS in 2015 to total between RM100 billion and RM105 billion.

MARC forecasts slightly lower government issuance in 2015, at between RM85 billion and RM95 billion, and flat growth for corporate bond issuances in the region of RM80 billion to RM90 billion.

However, MARC believes that local institutional funds will provide some buffer to external headwinds.

“The presence of large domestic institutional investors that serve as a strong buffer against external shocks remains an important mitigating factor against the risk of significant reversal of foreign flows,” says Zahidi.

This article first appeared in The Edge Malaysia Weekly, on January 19-25, 2015.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.