WHILE relatively high dividend yields will continue to attract foreign inflows into Malaysia’s debt market in the medium term, the pace of buying by foreign investors will likely moderate in view of rising Covid-19-related downside risks.

Amid elevated levels of Covid-19 infections in the country, the government has implemented stricter measures for the third movement control order (MCO 3.0) since Tuesday.

The MCO 3.0, which started on May 12, is scheduled to end on June 7.

One analyst with a local investment bank says the unabated Covid-19 surge has raised concern about the possibility of the MCO 3.0 being extended. This, he points out, will have a negative impact on the country’s economic growth.

“The uncertainty will dampen investors’ appetite for Malaysian bonds. So, we expect to see foreign inflows to slow down in the coming months, particularly since the debt market has already enjoyed 12 consecutive months of foreign inflows up to April, ” the analyst tells StarBizWeek.

Foreign funds extended their buying of Malaysian bonds, with inflows accelerating to RM6.4bil last month from RM5.9bil in March.

This stretched the foreign buying streak to 12 consecutive months, with cumulative inflows totalling RM60.2bil as at end-April.

More than 90% of the foreign inflows went to government bonds such as Malaysian Government Securities (MGS) and Government Investment Issue (GII), and these are mainly underpinned by long-term investors such as central banks, governments, pension funds and insurance companies.

Total foreign holdings increased to RM246.1bil, accounting for 15% of the total debt securities, in April from RM239.7bil, or 14.8%, in the preceding month.

For MGS alone, total foreign holdings last month rose to RM189.3bil, or 41% of the total MGS, from RM184.6bil, or 40.8%, in March.

Amid steady foreign appetite and abating selling pressure, domestic bond yields fell in April, with the benchmark 10-year MGS yield declining 10.8 basis points (bps) to 3.14%.

According to Malaysian Rating Corp Bhd (MARC), from beginning until mid-April, MGS yields along the belly till the long end fell as demand was largely supported by continuing optimism surrounding FTSE Russell’s reaffirmation of Malaysia’s membership in the World Government Bond Index.

“Other factors included lower US Treasury yields, firmer crude oil prices and the extension of mobility restrictions on most states, ” MARC says.

The rating agency expects gross issuance of MGS/GII to be around RM155bil to RM165bil this year, taking into account further upside risk to the budget deficit; the Strategic Programme to Empower the People and the Economy, or Pemerkasa, stimulus programme; proceeds from the US dollar sustainability sukuk; and the withdrawal from the National Trust Fund, or KWAN.

Yield spread

Kenanga Investment Bank, which projects a solid economic recovery for Malaysia, expects ringgit bond yields to return to an uptrend in the long term.

The investment bank expects the 10-year MGS yield to average at 3.2% in the second quarter of this year, before rising to 3.3% in the third quarter and 3.4% in the fourth quarter of 2021. It projects gross domestic product (GDP) to grow between 6% and 6.5% this year.

“We still expect foreign inflows into the debt market to continue in the medium term. However, inflows will likely moderate in the near term amid elevated local Covid-19 cases and the added tightening of MCO 3.0 measures, ” Kenanga says.

“Despite Covid-19 related downside risks, local bonds remain attractive due to high yield differentials and a projected recovery in Malaysia’s 2021 GDP growth, ” it adds.

The yield spread between the 10-year MGS and 10-year US Treasury Bond is expected to average at around 145 bps.

Cautious tone

Maybank Kim Eng (Maybank KE) maintains a mildly bearish outlook on the MGS.

“The fiscal-monetary policy mix for Malaysia, with additional rate easing unlikely but possible for more fiscal stimulus, will limit MGS strength or even push yields higher, ” the investment bank says.

According to Maybank KE, what matters more to bonds is the size of stimulus and how it will be funded, presuming one is on the cards.

“Wider deficit means more supply. While fiscal risk is real, the extent of slippage could be modest, ” it says.

“The pace of foreign inflows into ringgit bonds had been strong, although we would recommend caution after a record-setting 12th consecutive month of inflows, and we expect the US Federal Reserve’s quantitative-easing taper talks will heat up in the second half of 2021, ” it adds.

Maybank KE expects the 10-year MGS yield to hit 3.3% by the end of June, and 3.5% by the end of this year. On average, the yield is expected to average at 3.15% for the second quarter of this year.

Meanwhile, the recent pickup in US inflation has caused concerns among investors about emerging markets, including Malaysia.

The Institute of International Finance (IIF) notes that while inflation in emerging markets has also ticked up in recent months, it remains well-behaved overall, especially given the extent of the Covid-19 pandemic shock.

The cost of funding in local currency, as measured by yields of domestically-issued bonds, appears to be more responsive to global factors than to local inflation conditions, as foreign ownership of local emerging-market debt grew significantly, the IIF says.

“Local emerging-market bond yields would come under additional pressure if US long-term rates continued to rise, ” it adds.