by GANAGEASWARAN ARUMUGAM / graphic by MZUKRI MOHAMAD
YIELDS for Malaysian Government Bonds (MGS) have spiked recently possibly attributable to the spillover from rising US Treasury yields, which triggered a rout in bond markets globally.
The combined commodity price uptick and US$1.9 trillion (RM7.79 trillion) Covid-relief stimulus expected to be rolled out in the US have seen some inflationary pressures rise to the forefront.
The faster than expected vaccine rollout in the US coupled with a weather-led disruption in the US oil market in the past week has seen crude oil prices surge beyond the US$65 mark.
Given oil remains a major input for a wide range of sectors, market participants are pricing in a possible reflation, combined with the US$1.9 trillion stimulus package that will also increase US debt, causing the US Treasury yields to spike, particularly on the longer end. This phenomenon is known as steepening of the yield curve, which indicates investors are expecting rising inflation and stronger economic growth.
The spillover effect from the spike in US yields saw the local MGS yields spike as Malaysia’s bond market followed suit, albeit on a less steep degree.
The yield spike is more substantial towards the longer end of the curve with the benchmark 10-year MGS yield having risen by 430 basis points since the start of the year to a nine-month high of 3.09%.
Consequently, the yield spike has inflicted drawdowns for bond prices, where the BPAM All Bond Index has fallen 1.83% year-to-date up till March 3, 2021.
While the notion of inflationary pressures in Malaysia remains muted in the near term, the Department of Statistics Malaysia chief statistician Datuk Seri Dr Mohd Uzir Mahidin suggested inflation may make a comeback on the back of pent-up demand, projecting inflation to reach 2.5%, which could have also affected market sentiment.
We believe yields will stabilise and bond prices recover after this knee-jerk reaction due to:
1. Yield seekers to support bonds:
Malaysian fixed income has been on the receiving end of global fund inflow. In fact, the first two MGS auctions of 2021 saw over two times bid to cover which suggests that demand is still strong, despite the negativity surrounding the Fitch credit rating downgrade. This is due to the fact that Malaysia bonds still offer some of the more attractive yields on a real yield
basis and relative basis compared to global bond yields. After the recent spike in yields, we foresee yield-hungry investors returning which will drive up demand for bonds and consequently support bond prices.
2. Abundant domestic liquidity:
Other than demand from global investors, domestic investors are also flushed with liquidity, especially fixed depositors, and are looking for higher yields than the current low deposit rates. This could offset the lower demand from the Employees Provident Fund due to the i-Sinar outflows.
3. Low interest-rate environment:
Given the weak domestic economic backdrop, Bank Negara Malaysia (BNM) is unlikely to raise rates anytime soon with analysts expecting the next rate hike to come
only in the third quarter of 2022 (3Q22). That said, whether BNM cuts or not, the low-interest-rate environment will still be supportive for bonds.
Prior to this, with yields and rates at historical lows, we advised investors to shorten the duration of their bond portfolio and look for value in the lower grade/unrated bond segment.
Due to the aforementioned reasons, we opine that now is time to take advantage of the recent retracement, to increase duration and lock in higher yields in Malaysia bonds, especially in the lower grade/unrated bond segment.
At current yields and spreads, we also believe the downside risk is limited while the upside potential has increased, which means the risk-reward for this investment is more attractive now.
Ganageaswaran Arumugam is a fixed-income analyst at iFAST Research Team