Bond market to stay firm despite foreign outflows

PETALING JAYA: Malaysia’s bond market is expected to remain fundamentally supported despite recent foreign selling, with resilient domestic growth, contained inflation, attractive real yields and expectations of a more stable US interest-rate environment providing a buffer against external volatility.

Kenanga Research said Malaysia remained well positioned to attract foreign inflows, although geopolitical risks and uncertainty over the US Federal Reserve’s rate path could continue to drive capital flows in the near term.

“Despite recent outflows, we remain constructive on the local debt market, with supportive macroeconomic fundamentals, attractive real yields and improving ringgit prospects continuing to underpin foreign investor demand,” it said.

CIMB Research, meanwhile, said Malaysian sovereign bonds had diverged from the broader regional bond rally as investors reduced exposure to longer-duration securities ahead of a heavy supply calendar.

“Ringgit sovereign bonds traded cautiously over the week amid a heavy August supply calendar, with the curve bear-steepening as market participants trimmed duration,” CIMB Research said. The 20-year yield for Malaysian Government Securities (MGS) moved above 4%, while the 30-year yield stood at 4.16% as at Aug 7.

The near-term focus is likely to remain on government bond supply, particularly the RM5bil reopening of the 30-year MGS 7/55 today, comprising RM3bil through auction and RM2bil via private placement.

CIMB Research reported that when the reopening was announced, when-issued levels repriced sharply to 4.19%/4.16%, suggesting that investors were demanding additional yield concession ahead of the auction.

When-issued bonds refer to debt securities that have been authorised for issuance but are traded conditionally before they are officially printed, finalised, or settled.

The auction comes after a well-received RM5bil reopening of the five-year government investment issues (GII) 10/31 on Aug 4, which attracted a bid-to-cover ratio of 2.4 times and an average clearing yield of 3.529%.

However, CIMB Research noted that the strong auction had provided limited support to secondary-market trading.

Foreign investors had already turned net sellers of Malaysian bonds in July, recording RM5.6bil of outflows compared with RM4.9bil in June, according to Kenanga Research.

The selling was concentrated in longer-duration government securities as renewed US-Iran tensions, higher oil prices and elevated US Treasury yields prompted investors to reduce duration exposure.

Total foreign holdings of Malaysian debt declined to RM304.2bil in July from RM309.8bil a month earlier, while foreign ownership as a proportion of total outstanding debt fell to 12.9% from 13.2%.

MGS accounted for the bulk of the selling, with foreign investors recording RM7.4bil of outflows in July, compared with RM3.4bil in June. GII registered a smaller RM400mil outflow.

However, foreign demand was not absent from the Malaysian fixed-income market. Foreign investors increased their holdings of Malaysian Treasury Bills by RM1.4bil, while corporate bonds and sukuk attracted RM800mil of inflows.

Kenanga Research said external developments had outweighed Malaysia’s supportive domestic fundamentals in July.

“The Federal Open Market Committee’s hawkish communication reinforced higher-for-longer rate expectations, with markets still pricing a 54% probability of a September rate hike,” said the research outfit.

The backdrop has since become somewhat more favourable following weaker-than-expected US employment data. US non-farm payrolls fell by 23,000 in July, compared with expectations for an 80,000 increase, while downward revisions to May and June payrolls pointed to a cooling labour market.

CIMB Research said the data prompted markets to pare expectations for further Federal Reserve (Fed) rate hikes and drove US Treasury yields seven to 10 basis points lower in a bull-steepening move.

Nevertheless, Malaysia’s bond market faces competing pressures from domestic supply. CIMB Research said the recent increase in MGS yields could partly reflect portfolio rotation into corporate bonds amid heavier corporate issuance.

“Historically, corporate bond supply below RM15bil shows no clear relationship with credit spreads,” it said.

“However, when monthly gross issuance exceeds RM15bil, a positive correlation emerges between issuance and credit spreads, suggesting heavier supply may divert liquidity away from government bonds.”

Domestic economic data will also be closely watched. Malaysia’s June industrial production and wholesale and retail trade figures are due this week, ahead of the second-quarter gross domestic product release on Aug 14, with the advance estimate pointing to growth of 5.8% year-on-year.

With the overnight policy rate held at 2.75%, stable domestic monetary conditions and the prospect of an eventual easing in global rate pressures, the reports suggest Malaysia’s fixed-income market retains medium-term appeal even as investors remain selective over duration and cautious ahead of heavy government bond supply.

A fixed income trader with a regional bank told StarBiz that he is cautiously constructive on Malaysia’s bond market over the medium term, but would stay defensive on duration in the near term.

He acknowledged that the recent foreign outflows and upward pressure on longer-dated MGS yields are understandable given elevated US Treasury yields, geopolitical risks and Malaysia’s heavy issuance calendar, while corporate bond supply is also competing for liquidity.

“However, we would not interpret the foreign selling as a deterioration in Malaysia’s credit fundamentals: growth remains resilient, inflation is contained, the OPR is stable at 2.75%, and Malaysia offers relatively attractive real yields.

“More importantly, the weaker US labour-market data could eventually give the Fed room to move towards easing, which would be positive for Malaysian bonds and the ringgit,” he said.

The dealer is therefore expecting near-term volatility and further yield concession at the long end, particularly around large auctions, but see opportunities to accumulate duration gradually once US rate expectations become clearer.

“In other words, we would favour the five-to-ten-year segment over the very long-dated MGS for now, while remaining positive on the overall Malaysian fixed-income outlook,” he said.