Three reasons why the MGS yield spike is a great opportunity

As Malaysia corporate bonds are priced using MGS as benchmark, the corporate bond yield curve also saw an upwards shift


YIELDS on Malaysian Government Securities (MGS) have spiked to multi-year high on spill over from US treasuries.

The US Treasury (UST) yield curve saw a shift upwards in the past few weeks, with investors concerned about a longer than expected inflation environment, the acceleration of tighter monetary policy and the US government shutdown due to the debt ceiling.

In the Congressional hearing recently, US Federal Reserve chairman Jerome Powell once again warned inflationary pressures arising from the Covid-19 pandemic could last longer than previously expected, although he still believes they will be transitory. Although the House passed a bill that would suspend the US debt ceiling and avoid a government shutdown, the measure may not pass the Senate.

Congress did pass a bill that would fund the government through early December, but legislators still need to address the debt ceiling.

As the bill heads to the Senate, Republicans are threatening to block it, which could leave the Democrats scrambling to find another way to avoid a federal funding lapse — or even a first-ever default on US debt.

Worries about a looming default and the economic damage it would cause contributed to a US stock market drubbing last Monday.

The upwards shift in US treasury yields had a spill-over effect on the local MGS yield curve as well. Similarly, as Malaysia corporate bonds are priced using MGS as benchmark, the corporate bond yield curve also saw an upwards shift.

We see very attractive entry levels now, especially for the longer end of the curve which investors should not ignore and have listed three reasons why the MGS yield spike is a great opportunity.

1. Looks attractive on an absolute basis

As mentioned, the longer end of the yield curve suffered more during the recent sell-down but this is where we see the most attractive entry points.

The three-year (3Y) yield is around 2.63% per annum (pa) which is the highest since March 2020. The 5Y yield at 3.15% pa is trading at the highest level since November 2019, while the longer tenure 10Y yield at 3.61% pa has reached levels not seen since June 2019, more than two years ago and way above the pre-Covid-19 pandemic levels.

In other words, we think bond yields are looking attractive on an absolute basis, and bond investors can enjoy the attractive yields not seen in years.

2. Looks attractive relative to benchmark interest rate

Historically, MGS yields tend to track the benchmark Overnight Policy Rate (OPR) closely. However, this time round, the MGS yield spike occurred while OPR remained unchanged.

This could suggest the market has already moved ahead of the curve and priced in future OPR hikes.

In other words, we think the impact from further OPR hikes on MGS yields should be minimal going forward as most of the rate hikes could have been priced in already.

Looking at the spreads between MGS and OPR, currently we are at levels not seen since the global financial crisis in 2008/2009 and another indicator that MGS could be grossly undervalued.

In addition, bond investors can enjoy a substantial yield pickup compared to bank deposit rates which tend to track the OPR movements.

3. Looks attractive relative to US Treasuries

The spreads for MGS over US treasuries have also widened after the recent sell-down, particularly the 5Y and 10Y yields which are currently above 10Y average levels, which means the MGS yield spike has outrun its US counterpart’s.

In fact, we believe the widened spreads indicate the relative undervaluation of MGS.

Historically, spreads tend to revert back to the historical average, which could mean there is potential for the spreads to narrow with MGS yields coming down should UST yields stabilise.

On the other hand, the wider spreads also provide a cushion should UST yields spike further. In other words, we think the impact from further UST yield spikes on MGS yields should be less severe going forward.

We see very attractive entry levels for Malaysia bonds now especially in the longer end of the curve Malaysia bonds are priced based on MGS, and typically have a spread over MGS. Unfortunately, the recent spike in MGS yields would have negative implications especially for longer duration bonds or bond funds due to their higher interest rate sensitivity whereas the shorter duration bond funds should see smaller impact.

Although the recent yield spike was beyond expectation, it has created an unexpected opportunity for income seeking investors to lock in at higher yields, amid an environment where the benchmark interest rates are expected to remain at all time low at least until the third quarter of 2022.

In particular, we find the lower grade segment A-rated or below very attractive, as the yield pickup and spread are still very substantial, compared to the spreads offered by AAA or AA-rated bonds.

For example, 5Y A3-rated bonds are yielding 4.89% pa now, compared to 4.53% pa in mid-September.

Similarly, 10 year A1-rated bonds are yielding 5.65% pa now, compared to 5.38% pa in mid-September.

The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board.