This article first appeared in The Edge Malaysia Weekly, on July 18 - 24, 2016.

CENTRAL banks have taken centre stage as investors attempt to divine upcoming monetary policy loosening, following the UK’s Brexit vote. The two surprise rate decisions last week, however, point to more unpredictability in the coming months.

Bank Negara Malaysia’s newly appointed governor, Datuk Muhammad Ibrahim, took the market by surprise last Wednesday by announcing a pre-emptive 25bps cut to the overnight policy rate. In the UK the following day, the Bank of England did not meet expectations of a rate cut, opting to hold the bank rate at 0.5% until August at least while it waits for a clearer picture to emerge.

Meanwhile, Japanese stocks rallied following a major election victory by Prime Minister Shinzo Abe’s government, riding on speculation of further monetary stimulus to revitalise the faltering Abenomics growth programme.

Against this backdrop, positive jobs data and a rally in US equities to new highs raised fresh doubts on the ability of the US Federal Reserve to continue to put off a long-anticipated interest rate hike.

Overall, it has been a mixed bag of news. While the equity market appears to reflect this uncertainty, fixed income yields have painted a clearer picture. Following the surprise rate cut by Bank Negara last week, the yield curves of Malaysian Government Securities (MGS) and Government Investment Issues (GII) fell sharply — by between 6bps and 11bps.

Note that the dip in bond yields only added to an ongoing trend. Over the past one month, there has been a steady inflow of foreign funds into Malaysian bonds. As at last Friday, 10-year MGS yields had fallen to a three-year low of 3.523% (see chart).

“Monetary easing by global central banks are usually good for fund flows into the Malaysian fixed income and equity market. The prospect of US postponing its rate hike will also give emerging markets a foreign exchange boost,” explains Affin Hwang Asset Management Bhd head of fixed income Esther Teo.

Hence, while the ringgit initially fell following Bank Negara’s announcement, it quickly recovered on the back of fund inflows. At the time of writing, the ringgit was trading at 3.961 against the US dollar.

Interestingly, Mohammad’s most significant decision since he became governor also seems to be a departure from the style of his predecessor. The fact that Bank Negara caught the entire investment community almost completely off-guard raised speculation of more rate cuts.

Under the steady hand of former governor Tan Sri Dr Zeti Akhtar Aziz, Bank Negara seldom, if ever, surprised economists and analysts. This was despite the central bank’s policy of not managing expectations on monetary action.

Mohammad’s dovish stance seems to have sent a strong message, sparking talk of further rate cuts if the economy worsens. Some are even speculating that the stronger emphasis on supporting economic growth foreshadows a general election around the corner.

“We are factoring in another 25 bps cut with the possibility of the OPR being reduced to 2% to 2.25% should the macro conditions turn unhealthy,” AmBank Research said in a fixed income report the following day.

Following the knee-jerk reaction to his unexpected move, Mohammad also did something different from his predecessor — he engaged the media to clear the air.

“ … to say that there will be a series of rate cuts is not true, but it’s true we will keep an open mind every time we sit,” he told Bernama.

Interestingly, while Mohammad claims the rate cut is pre-emptive, he also affirmed his confidence in the country’s economic growth in the second half.

“It’s not that we expected growth to be weaker in the second half. We anticipate it to be stronger and that growth for the whole year is expected to remain between 4.0% and 4.5%,” he said.

Looking ahead, however, investors will be paying closer attention to the foreign central banks. As it stands, the outlook for emerging market bonds is upbeat due to the near-zero rates in developed markets. Now, more stimulus is expected.

“For the month of June, we saw a net bond inflow of RM5.7 billion into the MGS and GII markets. At current levels, foreign ownership of MGS and GII stands at 49.8% and 9.5% respectively of total outstanding bonds. We remain bullish on the ringgit bond market,” Teo tells The Edge.

“The low global rates environment, the prospect of concerted monetary easing by global central banks (Bank of England, Bank of Japan and the European Central Bank) and the prospect of Bank Negara cutting interest rates domestically would provide strong support to and inflow into the market,” Teo explains.

Rate cuts, and some form of monetary easing, is now expected from two of the world’s largest economies. The UK, still reeling from the unexpected Brexit vote, has to navigate carefully between stimulating the economy and keeping currency depreciation-led inflation in check.

Recall that the Bank of England last week maintained the bank rate at 0.5% by an 8-to-1 vote. There is not much room left to cut rates, but a 25bp cut in August is expected once the central bank has a better assessment of the impact of Brexit vote on the UK economy.

“The Bank of England may also consider other stimulus policies such as more quantitative easing besides rate cuts. Since Brexit, it has reversed its decision to hike the counter cyclical capital buffer for banks by 50bps, effectively to spur banks to lend by reducing the capital requirements,” explains Teo.

Meanwhile, Japan is expected to undertake more aggressive easing. The yen has already weakened to 105.7 against the US dollar, down 5.34% in one week. At the same time, the benchmark Nikkei 225 Index surged 9.21% during the week to 16,497.85 points last Friday.

“The market is getting excited on the prospect of Japan launching further stimulus to speed up the country’s exit from deflation. Japan is the first country to consider ‘helicopter money’ as a policy option after previous Abenomics attempts failed to weaken the yen, revive growth and drive the country out of deflation,” explains Teo.

Unlike quantitative easing, where the central bank “prints money” to buy back government debt, helicopter money is more akin to one-off distribution to everyone in the economy by the government to spur inflation. Unlike quantitative easing, which is seen as temporary because the central bank can reverse the buybacks, helicopter money is permanent for all intents and purposes. Note that such a stimulus has not been done in a modern financial system.

“If Japan goes ahead with its stimulus, it will be positive for Malaysian bonds and we expect to see more foreign inflows into the MGS markets. It will lead to risk-on sentiment and benefit emerging markets’ currencies, including the ringgit. Malaysian government yields still provide very decent yield in the environment where 40% of global developed market yields have fallen below zero,” explains Teo.

In the meantime, an MGS issuance last Thursday, just after the rate hike, shows that there is still plenty of domestic demand. According to a report by AmBank Research, most of the buyers were local pension funds and life insurers and there were only “selective foreign funds buying due to depressed global yields”.

Note that the government reopened the benchmark 15-year MGS with an issue size of RM15 billion, which managed to fetch an average yield of 3.826% — the lowest since January 2015 for similar issuances.

Interestingly, the book-to-cover (BTC) ratio that indicates interest in the issuance was lower than in previous issuances. But at 2.22 times BTC, it is still considered decent, notes AmBank Research in a report. 

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