RAM Rating Services Bhd senior economist and head of economic research Woon Khai Jhek
PETALING JAYA: Longer tenured ringgit bonds are set to be on the radar of foreign investors seeking higher returns as the United States Federal Reserve (Fed) rate hike cycle nears its peak.
This asset class is anticipated to attract foreign investors for both the government and corporate bonds.
Longer tenured bonds, which have a maturity of at least more than five years, are also able to meet institutional investors’ asset-liability matching and cashflow needs.
Foreign investors remained net buyers of Malaysian bonds for the fifth successive month in May this year, charting a net inflow of RM3bil (April: RM1.5bil) on expectations of the Fed ending its rate hike cycle.
The take-up was primarily for Malaysian Government Securities (MGS) and Government Investment Issues (GII), after a lacklustre April.
Foreign buying of MGS/GII in the first quarter (1Q23) consisted largely of “non-sticky” investors, while “sticky” investors largely sold down.
Sticky investors refer specifically to foreign central banks and governments as opposed to non-sticky investors.
The latter group of investors are the likes of asset management companies and banks.
RAM Rating Services Bhd senior economist and head of economic research Woon Khai Jhek told StarBiz investors had largely avoided longer tenured bonds last year amid duration risk arising from uncertainties from the Fed rate hike cycle.
“With signs of the interest rate hike cycle nearing its peak, investors are once again shifting their attention to longer-dated bonds.
“We should expect similar preferences from foreign investors for MGS as well. Longer duration bonds will still enjoy support from large institutional domestic investors for their asset-liability matching needs.
“Foreign investor buying has always largely focused on government bonds due to their liquidity. As of May this year, MGS and GII constitute around 93% of the total holdings of Malaysian bonds by foreign investors,” he said.
OCBC Bank (M) Bhd head of global treasury Stantley Tan
OCBC Bank (M) Bhd head of global treasury Stantley Tan said as interest rates peak this year, it is expected that investors would reach out to longer tenured bonds for higher returns.
The yield curve typically flattens at the end of the hiking cycle, he added.
“Demand for corporate bonds may outpace government bonds as investors seek greater return and this may tighten credit spread further while there has not been much outsized issuances corporate bonds year to date.
“There will also be natural demand for government bonds to replace maturing issuances over the next two quarters,” he said.
Bank Muamalat Malaysia Bhd Chief Economists and Social Finance head Mohd Afzanizam
Bank Muamalat (M) Bhd chief economist and social finance head Mohd Afzanizam Abdul Rashid agrees that investors would increasingly buy more longer dated securities as they are more sensitive to interest rate movement.
In other words, he said the upside potential in respect to bond prices is much higher for longer tenured bonds since the expectation of lower interest rate is gaining momentum.
MARC Ratings Bhd chief economist Ray Choy said foreign investors would likely continue to invest in benchmark securities across the yield curve, traditionally focused on government bonds due to the larger size and liquidity of the market as compared to corporate bonds.
On whether foreign inflows into the local bond market would continue this year, Maybank Investment Banking Group head of fixed-income research Winson Phoon said the foreign flows into ringgit bonds had been unexpectedly strong this year.
Maybank Investment Banking Group head of fixed Income research Winson Phoon
This is despite the weaker ringgit as favourable US dollar-ringgit hedging markets provide enhanced US dollar hedged returns to foreign investors, he said.
“We estimate US dollar-hedged three-year MGS yields of close to 6% and this compares favourably to the two-year US treasury (UST) yields of around 4.7% currently.
“We maintain a neutral to slightly positive outlook on foreign demand but would watch for risk factors that could reverse the flows,” he said.
Woon said he anticipates inflows for MGS this year on improved risk appetite and recovery in market sentiment.
As investors gradually move away from a “risk-off” mode, there is likely to be an increased appetite for riskier emerging market (EM) assets including Malaysian bonds, he said.
He said while Malaysia may not attract “yield-seeking” investors given the unattractive yield differentials against UST, the better overall market conditions should still support demand from investors looking to rebuild their EM exposure.
This could include those seeking to expand their EM portfolio or diversify their asset allocation as well as asset managers aiming to meet their index tracking requirements.
“However, the recent unexpected upward revision in US interest rate expectations will continue to put investors on the watch.
“The June ‘dot-plot’ from the US Federal Reserve (Fed) suggests the possibility of two additional 25-basis-point hikes by end-2023, which differs from March 2023’s projections indicating no further hikes.”
Woon said that currently, the yield differentials between UST and MGS have already narrowed to 2.15 basis points (as of the first half of June 2023).
“This narrower yield differential could dampen the appeal of MGS.
“Investors may choose to stay on the sidelines, pending the next Federal Open Market Committee meeting on July 25-26 for clues to where the peak Fed rate could end,” Woon added.
Afzanizam expects foreign inflows into the local bond market to continue as prospects for a lower interest rate environment are gaining momentum.
He said the global interest rate cut may not occur this year but the weakening trend in the economic indicator, along with the disinflationary trend, would make the case for long fixed-income securities an attractive investment proposition, given the inverse relationship between bond yields and prices.
“Fed is guiding the market that it might shift its monetary policy stance in the next two years.
“Given the sharp rise in bond yields since last year, it would make the bond prices to be quite attractive now. Already we saw RM15bil worth of net purchases for Malaysian bonds for the first five months of this year.
“With the ringgit being extremely undervalued, I would say more foreign funds would come and buy Malaysian bonds,” he said.
MARC’s Choy, on the other hand, believes the pace of foreign inflows may decelerate, given the need for investors to analyse incoming information due to changes in policies.
For example, he said, these measures include the implementation of new capital market initiatives by the government and the Madani economic narrative alongside the traction of execution by individual ministries and states in the months ahead.
As such, Choy said government policy would be closely watched by foreign investors due to the recognition of the evolving nature of an adapting regime.
On the whole, he said: “The local bond market will continue to grow this year on refinancing needs and steady issuances of government bonds due to accommodative fiscal policy.
“The challenges, however, will be that the bond market volatility will be driven by continued interest rate hikes in the United States, where the Fed is expected to increase the interest rate by two more times this year.”
As for the projection for the corporate and government bonds issuances this year, Phoon said he is maintaining the gross issuance forecast at RM172bil for government bonds, as he expects the government to meet or achieve a slightly better realisation than its fiscal deficit target for 2023.
For corporate bonds, he expects a gross issuance of RM110bil for private debt securities, supported by robust economic activities, conducive funding conditions and refinancing.
OCBC’s Tan said on the back of projected budget deficit, he expects to see about RM170bil of government bond issuances this year, while corporate bonds are expected to range between RM110bil and RM120bil.
Corporate bond issuances are expected to be slightly lower than the previous year due to a reduced government-guaranteed issuances this year, he noted.
