Tuesday, July 12, 2011

Malaysia Fixed Income Market Review, 3-9 July 2011

Fixed Income
Most players were seen staying at the sidelines ahead of the Monetary Policy Committee (MPC) meeting. However, weak Malaysia’s exports result and fears of Europe’s debt problem spreading sparked strong buying interest on 10-year benchmark Malaysian Government Securities (MGS) and Government Investment Issue (GII) from both local and offshore players pushed the yield down by 2 basis point (bps) week-on-week (WoW) to
3.92%. The 3- and 5-year benchmark MGS yields closed 3bps and 5bps higher at 3.25% and 3.54% respectively. Meanwhile, the 7-year benchmark MGS yield stayed unchanged at 3.71%.

On interest rate stance, Bank Negara Malaysia (BNM) unexpectedly left the Overnight Policy Rate (OPR) unchanged at 3.00% during the MPC meeting on 7 July 2011. The latest MPC statement reiterated higher downside risk to growth driven by uncertainties in global developments while domestic economy outlook remains positive. On inflation, risks are still on the upside and BNM reiterated that there remains upward pressure on prices driven by elevated commodity and energy prices with signs of demand-push pressure in 2H11. However, as largely expected, BNM raised the Statutory Reserves Requirement (SRR) by another 100bps to 4.00% effective 16 July 2011, continuing its efforts to manage excess liquidity in the financial system.

For local private debt securities (PDS) market, the momentum continued to be driven by profit-taking on previously issued primary issuance. The majority of the trades done during the week were from AA-segment, followed by Government-Guaranteed (GG)/AAA-segment. In the AA segment, buying interest was seen on power and banking bonds.

Fixed Income Outlook
On local macroeconomics, recent economic indicators in the US are charting mixed signal with general consensus that recovery is expected to be slow and patchy going forward. With the renewed fears on possible spreading of Europe’s debt, buying of US Treasuries pushed yields lower across the curve. Locally, we see no change in fundamentals and we expect domestic economy growth to remain sustainable driven by private investment and domestic consumption.

On inflationary concerns, further subsidy rationalization remains a swing factor. Delay in raising petrol prices has renewed speculation of an earlier General Election. Should this be in the agenda, we reckon subsidy cut will be gradual, capping CPI numbers for the rest of the year.

On interest rate stance, despite Bank Negara Malaysia (BNM)’s recent pause in interest rate normalization, we maintain our view that BNM will likely resume OPR increase by another 25-50bps in 2H11 with timing subject to the central bank’s assessment on evolving economic conditions and to the extent that the growth momentum is sustained.

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.

Meanwhile, momentum of foreign inflows into Malaysian government bonds and short-term bills remain unabated. Yield differentials between US Treasuries, positive currency outlook as well as manageable inflation remain positive for ringgit
fixed income assets. Having said that, the record high holding by the offshore investors do present risks should the reverse occurs.

For corporate bond market, new supplies so far have been well received. Meanwhile, 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
We maintain our slight underweight duration call across all fixed income. In terms of asset allocation, focus remains on corporate bonds.

We aim to participate in new issuance for further diversification and yield enhancement.

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

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