This article first appeared in The Edge Financial Daily on May 21, 2018

KUALA LUMPUR: While investors will be preoccupied with the impact of any policy change under the new government on local capital markets, the focus will shift to risks from the external sector once the dust settles.

Throughout last week, as the local bourse reopened following the historic outcome of the 14th general election that saw the end of the 60-year reign of the ruling Barisan Nasional, investors were busy scrutinising every policy change and major appointments made by Pakatan Harapan, looking for signs of how the new government will lead the country in the next four to five years.

The market started in the red as a knee-jerk reaction to the election outcome with the FBM KLCI falling 2.7% to a low of 1,797.14 points, but it quickly regained lost ground as the benchmark index crawled near to positive territory within the first 30 minutes.

In fact, investors appeared to have regained confidence in some of the reform agendas that the new government has proposed under Prime Minister Tun Dr Mahathir Mohamad.

The FBM KLCI has gained by 0.43% from its closing prior to the polling day on May 9, closing at 1,854.50 points last Friday.

Affin Hwang Asset Management director of equities strategy and advisory Gan Eng Peng said in a report that Malaysia will be touted as a reform play after resetting 60 years of policies, on the back of a healthy economy.

However, after uncertainties arising from the election outcome are removed, the external environment will continue to remain challenging.

Alexander Chia, head of research at RHB Research Institute, told The Edge Financial Daily a faster-than-anticipated inflation rate in the US could lead to more aggressive rate hikes, which would affect the stock market.

With the US 10-year Treasury yield breaching the 3% level and touching a high of 3.11%, a more aggressive pace of rate hikes by the US Federal Reserve (Fed) could trigger a selldown of the emerging market currencies. As of the time of writing, the US 10-year Ttreasury yield stood at 3.1%.

Chia noted that the market is currently pricing in three rate hikes by the Fed, although he thinks there could be up to four.

The concern is shared by Inter-Pacific Securities Sdn Bhd head of research Pong Teng Siew, who pointed out that a stronger US dollar has led to outflows in some emerging markets, including Malaysia. The ringgit was last traded at 3.9722 against the greenback.

The strengthening of the US dollar was seen recently as the US 10-year Treasury yield spiked on the back of higher oil prices, which are expected to accelerate inflation in the US. Brent crude breached the US$80 (RM317.78) per barrel level recently and was trading at US$79.68 per barrel at the time of writing.

Other than inflation, the US Treasury Department has been under pressure to fund the federal government’s budget deficit and increase the size of its debt auctions, leading to higher rates as well. Muted demand from Wall Street on the back of US President Donald Trump’s announcement that the US would pull out from the Iran nuclear deal also contributed to the rising yield.

Chia added that the “taper tantrum” seen in 2013 will be repeated.

Back then, the Fed hinted that it would look to unwind stimulus measures that were implemented to mitigate the global financial crisis in 2008. Recently, foreign investors withdrew more than US$5.5 billion from emerging-market debt markets when the US Treasury’s 10-year yield first touched 3%. The withdrawal was at a slightly faster pace than in 2013. A huge foreign fund exit could hurt emerging-market currencies, affecting liquidity of and sentiment on equity markets.

It is worth noting that about RM2.2 billion was sold off between Monday and Thursday last week as foreign investors sought to stay on the sidelines while waiting for the domestic uncertainties to fade.

Chia added that a trade war is another uncertainty on the external front.

Chinese technology giant and smartphone maker ZTE said last Wednesday it is ceasing “major operations” after the US banned it from doing business with American suppliers for seven years last month as punishment for illegal exports. There were also reports on American products being delayed in customs clearance as China stepped up inspections at its ports.

A US trade delegation to Beijing recently also highlighted the contrast between the demands of the world’s two largest economies. Reuters reported that China has insisted it will not change its stance on trade talks with the US even as top Beijing officials are expected to visit Washington for another round of negotiations.

Some progress also appeared on the news as there was talk of a report on a US$200 billion trade deficit offer by China, as well as Trump’s tweets on a potential lifeline given to China’s ZTE. Nevertheless, the external environment has been seeing some flip-flops in development and talks since Trump was elected.

Wilmar International Ltd, which is controlled by Malaysia’s richest man Tan Sri Robert Kuok Hock Nien, has warned that a tit-for-tat trade war between the US and China could hurt its oilseed business, with the possibility of China imposing tariffs on US soybeans.

“While these are things that have been developing for a while since Trump took over, not many people are pricing in the possibility of a trade war or escalating trade barriers. If that happens, the stock market is likely to face some negative pressures,” Chia said.

Another risk would be the geopolitical risk involving South Korea, North Korea and the US. While there have been positive developments with a potential US-North Korea summit next month, the recent news flow saw Pyongyang threaten to pull out from the historic meeting. Some US news portals suggested that Chinese President Xi Jinping could be the reason behind North Korea’s pushback against the talks. It’s uncertain what was the main reason for a sudden U-turn, but the tangling relationships between China and North Korea, and the US and South Korea, as well as the recent trade spat have started to gain market attention.