Thursday, May 12, 2011

Malaysia Fixed Income Market Review, 1 - 7 May 2011

Fixed Income
The Malaysian Government Securities (MGS) market traded range-bound as investors were sidelined ahead of the Monetary Policy Committee (MPC) meeting on 5 May 2011. Trading volume for government bonds also fell by some 41% week-on-week on shortened trading week.

Bank Negara Malaysia (BNM) raised the Overnight Policy Rate (OPR) by 25 basis points (bps) to 3.00%, resuming interest rate normalization the interest time this year. BNM also further raised Statutory Reserve Requirement (SRR) by 100bps to 3.00% effective 16 May 2011, to address the significant build-up of liquidity in the financial system. The Monetary Policy Committee Statement reiterated rising downside risks to global economy recovery on the back of higher energy and commodity, possible
supply disruptions post Japan’s earthquake as well as volatile capital flows to emerging countries. Domestically, BNM remains confident of continual economic growth.

Despite the 25bps interest rate hike, bond market was muted post announcement. MGS market remained well supported ending the week relatively unchanged. Yield on 3-year benchmark was down by 2bps to close 3.27%, 5-year up by 1bp to 3.56% while the 10-year closed at 4.03%.

On economic front, March 2011 exports moderated to 7.8% year-on-year (YoY), higher than consensus forecast of 4.2%, but retreated from 10.7% in the previous month as shipments of electrical and electronics products to US and Asia fell. Imports reported a 12.1% growth YoY, beating consensus’ 8.6%. Meanwhile, foreign reserves hit new high of USD130 billion in April, sufficient to finance 9.3 months of retained imports and 5 times the short-term external debt.

For local private debt securities (PDS) market, trading continued to focus on AAA- and AA-rated bonds. Separately, State Government commented on the expectation of positive outcome on the water issue while waiting for response and feedback from the Federal Government.

Fixed Income Outlook
On local macroeconomics, economy should remain sustainable albeit some slow down in momentum as seen in the latest economic data. Domestic consumption and private investment are expected to continue to drive economic growth. Consumer Price Index (CPI) numbers have been gradually climbing up. Nonetheless, further subsidy rationalization by the government remains a swing factor for any significant change in the inflation outlook.

The central bank’s move to resume interest rate normalization by another 25bps was not entirely surprising, given strong hints from the previous hawkish MPC statement in March. The latest statement continues to highlight higher downside risk to global recovery while domestic economy remains firmly on the steady growth path, justifying the 25bps hike this time. On inflation prospect, BNM reiterated upward pressure on prices in the 2H 2011 as commodity and energy prices are expected to remain elevated, coupled with domestic demand-pull factors. We expect BNM to continue to increase OPR by another 25 – 50bps in 2H 2011 with timing subject to the central bank’s assessment of growth and inflation outlook.

On supply and demand dynamics, the much anticipated Government related papers on the back of public or private funding needs arising from mega projects announced under the ETP have not been materialized. Further delay will widen the current supply demand gap given liquidity remain ample in the local financial market. On this backdrop, yield movements may be capped even though we are in a rate hike cycle.

In spite of much speculation on global capital movements in response to global uncertainties, momentum of foreign inflows into Malaysian government bonds and short-term bills was little affected thus far. While current sentiment and currency outlook remain favorable, the record high holding by the offshore investors present risks should the reverse occurs. We expect intensified suspicion of momentum reversal of capital flows on any signs of change in sentiment and waning Asian currency theme, especially in the current volatile external environment.

For corporate bond market, we maintain our view that credit fundamentals in general should continue to improve. While there were more bond issuance in the last two months, some of the new supplies were privately placed out to only selective investors. We view this unhealthy and should the trend persist, we are likely to see widening gap between demand and supply in the open market. This may also lead to adverse implications in terms of liquidity and pricing of the local credit market.
Unless more corporate issuance come on stream in the next few months, we expect the current valuation especially the popular high grade names to remain stretched due to insufficient supply with significant pent up demand for yields.

Fixed Income Strategy
Overweight corporate bonds with focus on “AA” rated bonds. Look to participate in new issuance for yield pick-up.

Source for MGS levels: Bond Pricing Agency
Source: ING Funds Berhad

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