Hedging uncertainty causes foreign selling in bond market

This article first appeared in The Edge Financial Daily, on April 21, 2017.
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KUALA LUMPUR: The “uncertainty over the ability to hedge” has been part of the reasons that have led to the bulk of foreign selling in the Malaysian bond market, but proactive measures by Bank Negara Malaysia (BNM) to improve the ability for foreign investors to hedge their ringgit exposure within the domestic system have showed signs of return of foreign interest, according to Affin Hwang Asset Management Bhd (Affin Hwang AM).

“As to why foreigners continue to sell [in the bond market], I think there is a little bit of uncertainty over the ability to hedge. I think foreign fund managers were a little bit concerned over their ability to hedge their ringgit exposure. Typically [in such scenario], they (foreign fund managers) will sell first,” said Affin Hwang AM chief investment officer David Ng during the market outlook presentation yesterday.

BNM has introduced its second series of development initiatives to expand and deepen the onshore financial market this month. One of the initiatives was the streamlining of its framework on hedging, as well as providing greater flexibility in hedging.

The latest measures were a follow-up to the central bank’s measures to curb speculation when it clamps down on the trading of non-deliverable forwards (NDFs) late last year. Ng shared that previously, the hedging of the ringgit’s exposure by foreign managers was done through trading of NDFs.

With the new framework, institutional investors, including companies, will be allowed to have a net forward hedging position of up to 100% of their underlying assets, compared with the previous 25% for fund managers.

In addition, residents will have freedom to hedge without documentary evidence of up to an aggregate net open position of RM6 million per client per bank, with the new framework extending it to other major currency pairs, such as pound sterling, euro and yen, on top of the US dollar and yuan.

Ng noted that there have been some signs of foreign funds returning of late.

According to Ng, the foreign fund outflow in the bond market during the first quarter of 2017 was one of the contributing factors to weakness in the ringgit against other currencies in the region.

“The ringgit is where it is today because all the things that could go wrong for the ringgit went wrong. The biggest driver of whether a country’s currency is strong or weak is really what the citizens of the country think. And we saw last year, Malaysians themselves were taking money out of the country. And as I shared earlier, this has stopped and we have seen a resumption in positive deposit growth,” he added.

Previously, Ng once pointed out that Malaysia’s deposit growth was in negative territory, an indication of the outflow of money out of the country.

With both of these negative factors subsiding as deposit growth returns to positive territory while outflows from bondholders taper, he anticipates that the ringgit’s direction moving forward should be strengthened and could reach RM4.20 against the US dollar by year end.

“In statistical terms, it (ringgit) has been trading at two standard deviations below its average over the last 10 years. In other words, it’s cheap,” he added.