Wednesday, August 17, 2011

Malaysia Fixed Income Market Review, 7 - 13 August 2011

Fixed Income
Malaysian Government Securities (MGS) momentum remained strong and continued to be driven by safe-haven flows, sparked by renewed concerns over bleak outlook for US economic growth and the European credit crisis. Strong buying was evident at the mid and long-tenured MGS, with the 5-year and 10-year Government Investment Issue (GII) leading the trading share. As an alternative to the pricier MGS, the 5- and 10-year GII rallied with yields pushed lower by 6 basis points (bps) to close on Friday at 3.45% and 3.80% respectively. Consequently, the 7-year and 10-year benchmark MGS yields 6bps to 3.54% and 3.66% respectively. Meanwhile, the 3-year benchmark MGS yield fell 1 basis point (bp) to 3.17%. In contrast, the 5-year benchmark MGS climbed 1bp to 3.40%.

On the local economic front, Industrial Production Index (IPI) increased by 1.0% year-on-year (YoY) in Jun 2011, after a contraction of a revised -5.6% in May 2011. The first rebound in two consecutive months of decline was due to higher growth in manufacturing output at 4.5% YoY (1.4% YoY in May 2011) and a rebound in electricity production at 3.6% YoY (-0.2% in May 2011). Despite the rebound, activities slipped into a contraction of 1.6% YoY in 2Q11 after moderating to +2.4% in 1Q11, which caused consensus to slightly downgrade Malaysia’s Gross Domestic Product (GDP) forecast for 2011.

As investors were mainly focused on MGS, the Private Debt Securities (PDS) market retreated during the week under review with continued interests seen on Government-Guaranteed (GG) as well as high-grade banking papers.

Fixed Income Outlook
Outlook for 2H 2011 is challenging amid multiple concerns on the external fronts, namely the signs of faltering US economic recovery, potential fallout from the Eurozone debt crisis and the downside risks from aggressive monetary policy tightening in large emerging economies. However, on local macroeconomics, the latest data release on June export growth beat market expectations and hence, we continue to expect the growth momentum for domestic economy to remain sustainable driven not only by the strong commodity exports, but also the private investment and domestic consumption on the back of gradual implementation of the Economic Transformation Programme (ETP) and low unemployment rate of 3%.

Given the above, emerging market bonds could benefit from the global headwinds, explaining the surge in foreign holdings of government bonds in Malaysia and elsewhere in the region since 2009 as they search for yield pickup opportunities. However, the record high holding by the offshore investors do present risks should the reverse occurs. In the short run, MGS yield curve should continue to flatten as market prices in further rate hike, pushing short-end yields higher while long-end continues to be supported given the constant demand from pension funds and insurance portfolios. Having said that, yield curve should steepen along the long-end of the curve once BNM is done with interest rate normalization in the medium-term. Nonetheless, we reckon significant steepening is unlikely based on the market flows stated above.

On interest rate stance, we reiterate our view that Bank Negara Malaysia will likely resume overnight policy rate (OPR) increase by another 25-50bps in the next 12 months with timing subject to the central bank’s assessment on evolving economic conditions and to the extent that the growth momentum is sustained.

Fixed Income Strategy
We maintain our slight underweight call across all Fixed Income. In terms of asset allocation, focus remains on corporate bonds. We aim participate in new issuances for further diversification and yield enhancement.

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

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