Wednesday, June 8, 2011

Malaysia Fixed Income Market Review, 23 May - 4 June 2011

Fixed Income
Buying interests on benchmark Malaysian Government Securities (MGS), mainly from offshore players in reaction to lower US Treasuries rates, were mainly skewed towards mid to long tenures with yields on 5-year easing 2 basis points (bps) to 3.53%, as well as 7- and 10-year shedding 3bps to 3.75% and 3.97% respectively. Meanwhile, on the back of a stronger Ringgit against the USD as market players expect the central bank to resume interest rate normalization in the next Monetary Policy Committee (MPC) meeting to curb accelerating inflation following the recent hike in gas and electricity tariffs, sent the 3-year benchmark MGS yield to climb 2bps to 3.32%.

As for the newly reissued RM4.0 billion 5.5-year Government Investment Issue (GII), the auction on Monday attracted a softer demand with bid-to-cover of 1.91x, at an average yield of 3.71% but was highly sought thereafter sending its yield easing 4bps to close at 3.67% on Friday.

The Malaysian government has announced an average of 7.12% electricity tariff effective 1 June 2011. In addition, gas tariffs for electricity and industrial sectors are set to rise by RM3.00/mmbtu every 6 months from 1 June 2011 to December 2015 until it reaches market level. However, the government assured that the electricity tariff increase will not affect 75% of domestic users who mainly consume less than 300 kWh per month.

For local private debt securities (PDS) market, trading interests continue to be dominated by AAA- and AA-rated bonds. A new “AAA (financial guaranteed)-rated” primary issuance of RM800 million was the largest contributor to the trade share. This was followed by bonds that are government-related as well as from banking and power sectors .

Fixed Income Outlook
On local macroeconomics, economic indicators in the US continued to chart weak numbers. Coupled with renewed concerns over Euro sovereign situation, US Treasuries reported another month of gains on safe-haven flows. Locally, economic numbers are expectantly showing slowing momentum. Nonetheless, we expect domestic economy to remain sustainable driven by private investment and domestic consumption on the back of gradual implementation of the Economic Transformation Programs (ETP) and low unemployment rate of 3%.

On inflationary concerns, while Consumer Price Index (CPI) numbers have been climbing up, market is getting mixed signal from the news on subsidy rationalization during the month. While further subsidy cut remains a swing factor to inflationary outlook, delay in raising petrol prices will like renew speculation of an earlier General Election. Should this be in the agenda, we reckon subsidy rationalization will be more gradual than expected, capping CPI numbers for the rest of the year.

On interest rate stance, following Bank Negara Malaysia (BNM)’s move to resume interest rate normalization by another 25bps, we expect BNM to continue to increase Overnight Policy Rate (OPR) by another 25 – 50bps in 2H11 with timing subject to the central’s assessment of growth and inflation outlook.

On supply and demand dynamics, industry sources have it that more issuance will come on stream in the 2H11 based on the current pipelines. This should help close the existing supply demand gap while ample liquidity and continual demand from pension and insurance funds will continue to lend support to the local market. On this backdrop, yield curve may continue to flatten in near term as market prices in further rate hike, pushing short-end yields higher while long-end being supported for now. Having said that, our medium term outlook remains that yield curve should steepen on supply risks once BNM is done with interest rate normalization although significant steepening is unlikely based on the market flows stated above.

Meanwhile, momentum of foreign inflows into Malaysian government bonds and short-term bills remain unabated, at least up to April. Latest foreign ownership as of April 2011 reported another record high at RM173.1bn from RM146.8bn previously, with net inflows into short-term bills amounted to an enormous RM23.2bn. While current sentiment and currency outlook remains favorable, the record high holding by the offshore investors do present risks should the reverse occurs.

For corporate bond market, we maintain our positive outlook on credit fundamentals in general. Despite more bond issuance in May, the actual offers to the open market were insignificant as some of the new supplies were privately placed out to only selective investors. 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 until more announcements on new corporate issuance in the 2H11, which in our view should lead to some correction in yields .

Fixed Income Strategy
We maintain our slight underweight duration call across all Fixed Income. In terms of asset allocation, focus remains on corporate bonds. We continue to like banking sector supported by the overall well capitalized domestic banking system with healthy asset quality and sustainable loan growth.

We aim to participate in new issuance for further diversification and yield enhancement. Last but not least, we look to trade MGS on high conviction.

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

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