DESPITE the rally in major bond markets on Thursday – resulting in yields falling sharply – as investors scaled back expectations on the pace of interest rate hike by the US Federal Reserve (Fed) to quell inflation, the sentiment towards this fixed-income category in general remains cautious.
For instance, Laffer Tengler Investments chief investment officer Nancy Tengler was quoted by Bloomberg as saying it is difficult to see a way clear to make a lot of money (in bonds), especially when real rates are negative.
Similarly, Sean Darby, chief global equity strategist at Jefferies, says “we are nowhere out of the woods in seeing higher bond yields going into next year”, according Bloomberg.
In tandem with the global trend, Malaysian bond yields could also face upward pressure.
Maybank Kim Eng (Maybank KE) at present maintains its yield forecast for the benchmark 10-year Malaysian Government Securities (MGS) at 3.5% by end-2021. But the brokerage notes the upside risks to the forecast, given the volatile US Treasury and developed-market yields.
“The near-term dynamics on MGS is still heavily influenced by global inflation and rates outlook, with less emphasis on local factors for the time being,” says Maybank KE fixed-income research head Winson Phoon.
DBS Bank is also forecasting an average yield of 3.5% for 10-year MGS for the fourth quarter (Q4) of 2021 through the first half of 2022. The financial group expects the average 10-year MGS yield to rise to 3.6% by the Q3’22 and 3.7% by Q4’22.
As for the benchmark 10-year US Treasury, DBS Banks expects average yield to increase from 1.6% in Q4’21 to 1.65% in Q1’22, 1.7% in Q2’22, 1.85% in Q3’22 and 2% in Q4’22.
Challenging factors
At a recent webinar on the impact of the Budget 2022 on capital markets by Maybank KE, Phoon notes there are two challenges faced by the Malaysian bond market, which have resulted in negative returns on a year-to-date basis.
“The first challenge is the supply, which we forecast to remain ‘heavy’ in 2022,” he says.
“The second negative on bond is the prolonged low overnight policy rate (OPR),” he adds.
Maybank KE expects total gross issuance of bonds to rise to between RM165bil and RM170bil from the estimated RM160bil in 2021, and the RM148.8bil issued in 2020.
Such levels are significantly higher than pre-Covid-19 levels of RM112.8bil in 2018 and RM115.7bil in 2019.
On the OPR, Phoon says: “At 1.75%, it has already reached bottom for quite some time and we expect Bank Negara to start hiking rates in 2022 by 25 basis points.”
Negative returns
Year-to-date, total return for Malaysian government bonds is -2.7% versus +7.4% in 2020 and +9.1% in 2019.
Phoon points out that bond returns in the past 15 years have been stable at around +4% and +5%.
“When there’s a rally, you get a better price. But this year, it is the opposite. It is payback time after two years of rally in 2019 and 2020,” he says.
The situation, however, is not unique to Malaysia.
“In the United States, year-to-date returns have also been negative for bonds. It is pretty much across the markets, with very few exceptions such as China and Indonesia,” Phoon explains.
“In terms of bond classes, there are few places to hide this year. Most returns have been negative. The only exceptions have been the high-yield sectors in Europe and United States, and inflation-protected bonds,” he adds.
According to Phoon, the Malaysian bond market has largely priced in a potential interest rate hike by the Fed.
It has also priced in a gradual normalisation of the OPR to about 3% to 3.25% in the next two years.
Overall, Maybank KE’s is still “neutral” in terms of its outlook on MGS, and mildly bullish on duration.
“We have been bearish on the market for quite some time but now are a turning more constructive,” Phoon says.
He sees the Budget 2022 as having a “neutral” impact on Malaysia’s sovereign rating.
“Medium-term fiscal consolidation in the budget is still intact. The government is actually targeting to reduce the fiscal deficit-to-gross domestic product (GDP) ratio to an average of 4.5% in 2023 and 2024, which I believe should be welcomed by the bond market,” Phoon explains.
The government expects Malaysia’s fiscal deficit to narrow to 6% of GDP in 2022 from 6.5% of GDP this year.
Last December, Fitch Ratings downgraded Malaysia’s long-term foreign currency debt rating by one notch to BBB+.
In June, S&P Global Ratings affirmed Malaysia’s foreign currency and local currency long-term issuer ratings at A- and A, respectively, with a negative outlook.
Phoon says he expects Fitch and Moody’s to keep Malaysia’s sovereign rating at BBB+ stable, and A3 stable, respectively.
“The only risk is with S&P, which has a negative outlook on Malaysia,” he says.
“If you look at the current credit metrics for Malaysia, we are actually slightly below the so-called downward triggers. So, the key question is whether Malaysia’s medium-term fiscal consolidation is sufficiently big enough or fast enough to avert a rating downgrade,” he adds.
DBS Bank chief investment officer Hou Wey Fook says investors remain vigilant of future debt rating downgrades on Malaysia because of the political uncertainties.
“There are some prospects for an increase to the statutory debt limit to 65% of GDP, which would drive expectations for wider fiscal deficits and higher bond supply for this year and next.
Near-term bond supply-demand outlook also argue for higher bond yields – foreign bond inflows have been losing momentum at a time when issuances are expected to be ramped up going into year-end,” he says in a recent report.
MGS saw huge net foreign outflows in September, Malaysian Rating Corp Bhd (MARC) notes in a recent statement.
The local credit rating agency observes that foreign holdings of MGS fell RM2.4bilbil (August: +RM3.1bil) to RM189.3bil (August: RM191.7bil).
“Foreign ownership of MGS remained at 40.3% of total outstanding. Foreign demand for MGS was partly offset by the large redemption that occurred in the same month at RM11.7bil,” it says.
Year-to-date, foreign interest in MGS remains strong despite the global bond sell-off in September, MARC points out.
Cumulative net foreign inflows for January-September 2021 stood at RM12bil, compared with RM5.3bil for January-September 2020, with MGS being the largest contributor for foreign net inflows year-to-date.