Fixed-income investors should continue to stay invested in Malaysian bonds and seek opportunities in lower-rated credit
by IFAST RESEARCH TEAM / pic TMR
2022 was definitely a year like none other. Starting from the Russia-Ukraine War to persistently high inflation, to the ramping interest rates which saw many central banks hike their interest rates to decades-high levels. The result was a tempest, as it is the first year that US stocks and long-term bonds are both down more than 10% in the last 150 years.
Global bond yields spiked, while bond prices tumbled down upon the massive sell-off. While most fixed-income and equity markets suffered, Malaysian bond market was relatively resilient.
For 2022, Malaysia-centric bonds remained resilient as they outperformed global peers, as well as when compared to global equities, ending up in the positive territory, while other indexes tumbled upon rising yields and global inflationary pressure.
The year 2023 already appears rife with headwinds, including continued inflationary pressures, softer domestic economic growth, recession fears and uncertainty over the global interest rate upcycle.
Abundant Domestic Liquidity
Being a victim of the US Federal Reserve’s (Fed) aggressive rate hike cycle, the local bond market was not spared from the global rout, with yields spiking across the yield curve, almost erasing the positive gains in the last two months. However, the yields offered were able to cover the losses from the declining bond value; therefore, the Malaysian bonds were able to record positive total return in year to date (YTD) and in the last quarter.
Nonetheless, it was worth noting that unlike global markets, the Malaysian Government Securities (MGS) yields did not break the 4.6% threshold, thanks to dip-buying interests from the local institutions. Meanwhile, the expected 25 basis points (bps) hike in November 2022 was almost treated as a non-event as the market has priced in sufficient rate hike buffers. Back in third quarter of 2022 (3Q22), as yields started to pick up and surpassed pre-pandemic levels, we recommended investors to increase the duration of their Malaysian bond portfolios.
Despite weak inflow from foreign investors, the domestic bond market is flooded with inflow from local players, prominently from banking institutions as shown in the YTD inflow into domestic government debt by buyers as of September 2022. More inflow towards the local fixed income market in the 3Q22. See Chart 1.
Yields Have Priced Most of the OPR Hikes
Although Malaysia’s inflation has declined compared to a month ago, we do not expect Bank Negara Malaysia (BNM) to suddenly make a 180% turnaround on its stance. Meanwhile, in the absence of any catalyst pointing towards a change in the Fed’s hawkish tone, bond yields will remain elevated. This is in line with Fed’s statement after delivering a 50bps hike in December, citing that it does not foresee any rate cut in 2023 given current economic conditions.
Based on the central bank’s gradual and measured approach, we expect at least two more hikes from BNM with 25bps each to bring the Malaysia’s Overnight Policy Rate (OPR) to 3.25%. However, as mentioned, we think that current bond yields have already priced in sufficient rate hike buffers and now assume a normalised OPR of 3.25%. Therefore, we expect less surprise on rate hikes to hit the Malaysia’s fixed income market. See Chart 2.
Sudden Rate Hike
Although BNM is unlikely to pivot in the next Monetary Policy Committee (MPC) meeting, we think that there is a lower possibility of a sudden unexpected rate hike moving forward.
Will BNM pivot in the next MPC meeting? The Malaysian economy posted an impressive growth of 14.2% year-on-year (YoY) for 3Q22. Overall, the Malaysian economy expanded by 9.3% in the first three quarters of 2022 and was projected to surpass the government’s target of 6.5%-7% in 2022. More recent leading indicators, such as the Leading Economic Index and Industrial Production, continue to paint a resilient macro picture for Malaysia. Malaysia’s inflation rate remained accommodative relative to its peers, while the country recorded the third consecutive slower growth in inflation as of October 2022. We think that the resilient domestic economy gives BNM leeway to further adjust the degree of monetary accommodation and support the post-pandemic economic recovery. Although we think that BNM is unlikely to pivot away from its current monetary stance, we expect less probability of an unexpected rate hike.
Stay Invested, Embrace Income
Fixed-income investors should continue to stay invested in Malaysian bonds and seek opportunities in lower-rated credit.
At this current juncture, we continue to advocate short-to medium-duration Malaysian bonds for investors to take advantage of the rising interest rate environment, in order to enjoy attractive coupons and decent spreads as the yield curve has gotten much flatter than in the beginning of the year, while on the other hand, only taking a rather limited risk, as we think that most of the hawkishness has been priced into the current yields already.
Meanwhile, looking at the average yields for corporate bonds of different credit ratings, we recommend to go for the lower end of investment grade due to its substantial spreads over risk-free rate, giving investors a good yield pickup but still staying within investment grade. The spreads also provide decent cushion during market volatility as seen in 2022.
As investors wait for this sequencing to play out, they should embrace income. We think that this is an exceptional environment for generating satisfying single-digit returns from high-quality assets, an opportunity that hasn’t presented itself for a long time.
On balance, we believe the risk-reward for Malaysia’s fixed income is attractive due to abundant domestic liquidity, local bond yields having priced in sufficient rate hikes and bonds being traded at very attractive levels.
The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board.
- This article first appeared in The Malaysian Reserve weekly print edition