Local bond market risks negative impact from US rate hike

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The local bond market will be more vulnerable if there are interest rate hikes in the US in the coming months. In an interview with Personal Money, Danny Wong, CEO of Areca Capital Sdn Bhd, explained that this is due to the high foreign holdings of Malaysian government bonds.

“The potential impact on the bond market will be higher than on the equity market. Assuming no proper measures are in place, a major selldown of foreign holdings in our bond markets will pull down prices and increase yields.”

If this happens, Wong says the exit of foreign funds will have a chain effect on foreign exchange rates and corporate earnings.

“Our local currency will take a hit. Despite a weakening ringgit benefiting exports, there is a risk of triggering imported inflation, as imported goods and raw materials will be more expensive. As a result, corporates will experience margin compression.”

Furthermore, the increasing bond yield environment could potentially raise the cost of borrowing. “Corporates would have to pay higher interest rates to raise money if yields continue to rise,” Wong says.

According to Bank Negara Malaysia’s website, foreign ownership of Malaysian government securities have increased this year, standing at RM148 billion, or 47.3% of the total amount, in August. This figure is slightly lower than the record high of RM154 billion in July, or 48.4%. According to an economist from a local research firm, foreign holdings in the equity market edged up slightly to 23.6% at the end of August from 23.2% in the beginning of the year. However, the figure is expected to drop in the last two months due to the further selldown of foreign funds, said the economist.

Nevertheless, Wong believes Bank Negara will take precautionary steps to cushion the potential impact. “Apart from raising interest rates, the central bank can mobilise its foreign reserves to buy these bonds should there be a sudden and major withdrawal of foreign funds.”

To mitigate this risk, Wong says investors should consider moving their funds to the equity market. “If you see the wave [interest rate hike] coming, you can avoid it [the impact]. By then, the risk associated with bonds and equities will be the same, so why don’t investors go for equity instead?”

Investors who are still interested in the fixed income market can opt for short-term bonds and real estate investment trusts (REITs) as an alternative.

“In anticipation of a rate hike, investors should consider compromising slightly on the interest income and yield in short-term bonds, which allow them to roll over upon maturity. Such bonds will not be affected so much as they are nearer maturity,” explains Wong.

“REITs are more liquid instruments. Some of the retail ones, such as IGB REIT and Pavilion REIT, are in huge demand and still performing well,” he adds.