Kenanga Research expects the domestic debt market to regain momentum amid a potential return of risk appetite.
PETALING JAYA: High US treasury yields amid heightened geopolitical concerns will likely keep investors in low risk mode and in safe havens like the US dollar assets at the expense of emerging markets currencies and assets in the short term, says analysts.
They think the Middle East conflict, volatile energy prices and uncertainty over the Federal Reserve (Fed) policy given the mixed data and sustained inflationary pressure, keeps another 25 basis point (bps) hike option on the table in December for the Fed.
This has, however, led opportunistic foreign investors to continue divestment of ringgit assets like debt securities for the third straight month in October to the tune of RM2.6bil after shorting RM4.4bil worth of Malaysian Government Securities in September.
That added with the net outflow of RM2.2bil from the local equity market last month, after three months of net inflows saw the ringgit retest historic lows of RM4.79 against the US dollar late last month.
“The Fed emphasised the expectation of maintaining higher interest rates for an extended period, contingent on forthcoming economic indicators. This implies that the current yield differential between Malaysia and the United States may persist, offering an advantageous carry trade for those investing in US bonds while divesting from ringgit bonds.
“The likelihood of Malaysia raising interest rates is diminished, considering the emphasis on fostering local economic growth, especially with sustained healthy domestic inflation,” chief investment officer at Tradeview Capital Nixon Wong told StarBiz.
The rising interest differentials between the two countries is encouraging the carry trade into the greenback by foreign exchange (forex) traders and selling of the ringgit.
Forex traders are borrowing money in the local unit and converting into US dollars to gain from the rate differentials, analysts said.
Conversely when investors are expecting the Fed has hit its terminal rate, traders will sell the greenback and purchase the ringgit to close the carry trade, subsequently increasing the demand for the latter and potentially leading to appreciation.
Despite potential lower demand impacting the ringgit’s appeal, iFast Capital sees limited downside risk for the ringgit and the room to gain from structural changes proposed by the new Madani Economy over the longer term.
“With the Madani Economy framework unveiling, targeted spending and subsidies could improve the country’s fiscal position. Consequently, we project that ongoing modest inflation may not be sustained, influenced in part by generous subsidies.
“Despite the fact that the ringgit might be impacted by the Fed’s monetary policy in the near term, we see a structural transformation in local currency dynamics and we hold a positive view towards ringgit over the long term,” its research analyst Kevin Khaw Khai Sheng noted.
The consumer price index data due this week in the United States could set the tone for markets in the near term.
The market consensus is for US inflation to moderate to 3.3% year-on-year, down from 3.7% in September.
A stronger-than-expected figure may fuel expectations for prolonged monetary tightening, prompting capital outflows from the local market as higher interest rates and a robust dollar gains support.
It will also see the Fed and other Asian central banks continue to sound fairly hawkish and ensure no interest rate cuts anytime soon. In fact, to defend the rupiah, the Bank of Indonesia raised its rates by a quarter per cent to 6% last month.
The expectations of a stronger year-end close for the ringgit-dollar pair is also thinning due to the challenging longer-run outlook for China due to its prolonged property sector downturn, ongoing demographic deterioration and reshoring activities by multi national companies amidst heightened geopolitical tensions.
“The recent unfavourable development at one of the biggest housing developers –Country Garden – could jeopardise the near-term consumer sentiment, subsequently weighing on the demand. Being one of the largest trading partners with Malaysia, the lacklustre demand in China will negatively impact ringgit demand,” Khaw said.
Wong of Tradeview said the value of the ringgit would be correlated to policy actions and the performance of China’s economy, adding maintaining a competitive local unit position remains imperative.
He also sees a relatively limited impact on the ringgit and local markets from a potential move by the Bank of Japan to abandon its yield curve control policy, with the primary repercussions more likely to manifest in the fund flows between Japan and the United States.
While foreign money may be lowering exposure to local debt, liquidity and investor interest in ringgit debt securities remains strong.
A recent government auction of RM3bil in long tenor government investment issue (maturing in May 2052), received healthy incoming bids from investors to the tune of RM6.2bil, translating into a bid-to-cover ratio of 2.08 times.
Thus, Kenanga Research expects the domestic debt market to regain momentum amid a potential return of risk appetite.
“Despite the ongoing headwinds confronting cyclical assets, we anticipate an influx of foreign capital in the near-to-medium term as a result of a possible rotation in asset allocation. Given our assessment that the Fed fund rate has already peaked, bond investors may progressively pivot away from the United States and rebuild their positions in emerging markets,” it stated in a recent report.
The research house added foreign holdings in Malaysia’s debt market tend to rise 6 to 12 months following the conclusion of the Fed tightening cycle.
Kenanga Research added with Bank Negara is expected to maintain its current policy stance until at least end-2024.
Alongside the government’s pursuit of fiscal consolidation and the solid underpinnings of the domestic economy, it sees investors potentially increasing their acquisition of Malaysian assets in pursuit of carry returns and capital appreciation.
