Malaysia Bond Flows Update Foreign net selloff lower in August, foreign buying to increase on improving fundamentals Economics Kenanga Investment Bank Berhad T: 603-2172 0880 OVERVIEW Foreign selloff moderated. The decline in foreign holdings of total Malaysia s securities moderated in August, totalling just RM0.7b (July: -RM2.3b). The outflows were led by GII (-RM3.2b), followed by Malaysian Treasury Bills (-RM0.5b). However, the foreign holdings of MGS increased by RM2.1b in August. Falling U.S. Treasury yield on dovish Fed. The Fed appeared to favour a slower pace of rate normalization, driving U.S. Treasury yield lower. We expect to see some yield chasing activities with more funds expected to switch into relatively higher yielding assets in emerging markets including Malaysia. Rising geopolitical risks. The North Korea missile testing that began in February and the latest last week has created tensions around the world, resulting in increased demand of U.S. safe haven assets and driving down Treasury yield. The resulting fresh United Nations sanctions on North Korea and the threat of retaliation would pose a risk to the financial markets. Fundamentals to drive demand. We expect continued foreign demand on Malaysian debt securities in the coming months on the back of Malaysia s strong fundamentals. This would also lend support to the ringgit and convince BNM to maintain its accommodative monetary stance. Smaller foreign outflows. The foreign holdings of Malaysian debt securities declined at a slower pace in August. Total foreign outflows on Malaysian debt securities moderated to RM0.7b from RM2.3b in July. Year-to-date, domestic debt market still experienced a considerable RM23.9b of foreign outflows, with the worst outflows for the year registered in March, totaling RM26.2b. Graph 1: Foreign Bonds Transactions MYR bn 20 10 0 Short-Dated securities Bonds (MGS & GII) All Malaysia securities MGS inflows underpinned holdings. The outflows were mainly attributable to a RM3.2b fall in Government Investment Issue (GII) (Jul: -RM0.7b) and a RM0.5b decline in Malaysian Treasury Bills (Jul: -RM0.2b). However, foreign investors appeared to place their preference over MGS in August. The foreign holdings of MGS rose by RM2.1b in August, largely offsetting the foreign selling of other debt categories. -10-20 -30 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Consequently, foreign holdings of MGS increased to 40.3% from 40.1% in July; whereas GII dipped to a 17-month low of 6.3% in August Mild equity outflows. Meanwhile, the equity market saw its first monthly capital outflows for the year in August after an uninterrupted seven months of foreign inflows. Foreign net selling of local equity amounted to RM0.2b in August (July: +RM0.4b). Though we may want to believe that the foreign funds flows is taking a breather, investors were mainly spooked at the height of North Korea nuclear testing issue in August. Nonetheless we expect investors to return to the equity market in the near term as the resilient economic conditions lead to higher corporate performance and earnings. Year-to-date, net foreign flows reached a solid +RM10.3b in August, compared to the +RM2.7b registered in corresponding period last year. PP7004/02/2013(031762) Page 1 of 5
Lingering 1MDB risks. Investor sentiment played a major role in influencing capital flows. 1MDB s failure to meet its USD602.7m repayment obligation to its creditor, the International Petroleum Investment Company (IPIC), has triggered an outflow in July that trickled into August. Investors concern on 1MDB s ability to meet the Aug 31 extension deadline might have contributed further to the outflows in August. As 1MDB eventually fulfilled its repayment obligations before the Aug deadline, its related risks in the debt market may have subsided for now. However, it is important to note that there could remains some lingering 1MDB related risks in the medium term as it is required to settle the remaining portion of the USD602.7m debt by the end of the year. Hence, the market might be vulnerable to any adverse developments related to 1MDB. In the meantime, foreign investors will likely focus more on Malaysia s strong fundamentals. Graph 2: Foreign Bond Holdings of MGS and GII % Share 60% MGS GII 50% Bonds (MGS & GII) 40% 40.3% 30% 26.4% 20% 10% 6.3% 0% Aug-09 Aug-11 Aug-13 Aug-15 Aug-17 Graph 3: Portfolio Equity Flows Reserves rose steadily. In spite of the outflows in debt and equity market, foreign reserves expanded in a convincing fashion. This could possibly be due to repatriation of export earnings and to some extent higher long term investment flows or FDIs. Malaysia s foreign reserves rose USD1.1b to USD100.5b at end- August, breaking the USD100.0b psychological level for the first time since July 2015. This is sufficient to finance 7.8 months of retained imports and 1.1 times of shortterm external debt. The stable increase in foreign reserves throughout the year is mostly driven by the strong ringgit and exports performance. Moving forward, a larger buffer of reserves and a stable ringgit could lift foreign investors confidence to invest in Malaysian assets and predictably provide a boost to asset prices. Source: Bursa KL, Kenanga Research Graph 4: Malaysia-U.S. Debt Yield Spread (%) MGS - UST 5yr generic yield spread 3.0 MGS - UST 10yr generic yield spread 2.5 2.0 1.5 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 PP7004/02/2013(031762) Page 2 of 5
US yield down on dovish Fed. Minutes from the Fed s July meeting and comments of Fed policymakers to the press indicated that the Fed is increasingly less hawkish and leaning towards dovishness amidst stubbornly weak inflation and sluggish wage growth. (See US Fed Comments for details). The market has now pushed back the timing of Fed s next expected rate hike, with the Federal Fund Futures implied probability for another one-off 25bps rate hike before the year end at 35.2% (as at Sept 12). The U.S. 10-year Treasury yield has fallen to as low as 2.04% last week after the Fed comments from around 2.17% at the beginning of the month. As such, we would likely see some yield chasing activities with more funds expected to switch into higher yielding assets in emerging markets including Graph 5: Ringgit Performance against Major Currencies -3.1% 0.27% -5.4% -0.22% -2.6% -0.34% 3.7% -0.81% -3.8% -4.24% -9.1% -5.96% -8.8% 6.68% USD CNY GBP JPY SGD year-to-date 12-months AUD EUR -10% 0% 10% Source: Bloomberg, Kenanga Research Malaysia. Malaysia government debt securities have also seen a decline in yield in the past week, which might be indicative of increased demand for Malaysian debt assets. Currently the 10-year bond yield spread between MGS and US Treasuries remains stable at around 170 basis points (bps) as at Sept 12 compared to a three-year average of 187. Geopolitical risk. The most recent North Korea missile testing conducted last week has created much tensions and uncertainties in U.S. and around the world, resulting in a shift of investors demand toward U.S. safe haven assets and driving down U.S. Treasury yield. Consequently, the dollar weakened and the USDMYR pair dipped slightly below 4.20 level last Friday (Sep 8) This was a sharp decline considering that the USDMYR has been trading within a narrow range of 4.26-4.30 since end-may. Year-to-date, the ringgit has appreciated 6.7% against the US dollar. Although the North Korea risk has subsided somewhat following North Korea s restraint in conducting another missiles testing over the weekend, the financial market remains wary of the developments of United Nations sanctions over North Korea and the country s next course of actions or retaliation. Nevertheless, going forward, we believe fundamentals will play a bigger role in driving the ringgit trend. On the back of improving fundamentals, we maintain our year-end target for the USDMYR at 4.15 though we do not discount the possibility that it may test the 4.10-level in the near to medium term while remaining volatile. Fundamentals to drive demand. As with our previous reports, we continue to believe that foreign investors will focus on Malaysia s strong fundamentals in their investment decisions. Our assessment of Malaysia s strong fundamentals is partly based on its adequate reserves buffer, stable ringgit, improving domestic demand and robust exports performance. In the latest released trade data, Malaysia exports registered a stronger than expected growth of 30.9% YoY in July. In view of brighter outlook on Malaysia s fundamentals, we expect Malaysian debt securities to continue attract interest from foreign funds. As such, we see fund flows in domestic debt market to remain steady and fluid. This would be enough to convince BNM to maintain its overnight policy rate (OPR) for a long time, most likely this year or beyond. PP7004/02/2013(031762) Page 3 of 5
Table 1: Foreign Holdings of Malaysian Bonds MGS Gll BNM bills (conventional) BNM bills (Islamic) Total Malaysia securities* *Including PDS Dec-16 Apr-17 May-17 Jun-17 Jul-17 Aug-17 168.5 141.6 150.5 149.6 148.9 151.0 % of Total MGS 47.1% 39.7% 41.8% 41.2% 40.1% 40.3% 21.5 20.1 20.2 20.3 19.6 16.4 % of Total GII 9.2% 7.9% 7.8% 7.8% 7.4% 6.3% 8.1 5.7 6.9 6.9 5.9 6.2 % of Total BNM Conv bills 92.3% 66.6% 71.4% 93.6% 92.8% 96.9% 0.0 0.0 0.0 0.0 0.0 0.0 % of Total BNM Islamic bills 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 199.9 168.5 178.4 178.0 175.3 174.0 % of Total Securities 31.5% 25.7% 26.7% 26.6% 25.9% 25.8% PP7004/02/2013(031762) Page 4 of 5
KENANGA MACROECONOMIC FORECAST 2010 2011 2012 2013 2014 2015 2016 2017F Real GDP (%YoY) 7.2 5.3 5.5 4.7 6.0 5.0 4.2 5.4 Consumer Price Index (avg.) 1.7 3.2 1.7 2.1 3.2 2.1 2.1 4.1 Current Account Balance (% of GDP) 10.1 10.9 5.2 3.5 4.4 3.0 2.4 1.6 Fiscal Balance (% of GDP) -5.3-4.7-4.3-3.8-3.4-3.2-3.1-3.0 Unemployment rate (% ) 3.3 3.1 3.0 3.1 2.9 3.2 3.3 3.4 Manufacturing output (%YoY) 11.1 5.7 5.2 4.2 6.1 4.8 4.3 5.7 Exports of goods (%YoY) 15.6 9.2 0.7 2.5 6.4 1.6 1.1 21.6 Overnight Policy Rate (end period) 2.75 3.00 3.00 3.00 3.25 3.25 3.00 3.00 Exchange rate: Ringgit/US$ (avg.) 3.2191 3.0585 3.0886 3.1501 3.2729 3.9074 4.1424 4.3000 Exchange rate: Ringgit/US$ (end period) 3.0635 3.1680 3.0580 3.2757 3.4973 4.2943 4.4862 4.1500 Palm oil: RM/tonne (avg.) 2,701 3,219 2,764 2,371 2,384 2,166 2,649 2,549 Palm oil: RM/tonne (end-period) 3,759 3,161 2,231 2,573 2,283 2,198 3,203 2,550 Crude Oil (Brent)- US$/barrel (avg.) 80.34 110.91 111.68 108.70 99.45 53.56 41.00 51.00 Crude Oil (Brent)- US$/barrel (end-period) 94.75 107.38 111.11 110.80 57.33 37.28 56.82 50.40 Source: BNM, Ministry of Finance, Dept of Statistics, Bloomberg, CEIC, PORIM, Kenanga Research, P=Preliminary; F=Forecast This document has been prepared for general circulation based on information obtained from sources believed to be reliable but we do not make any representations as to its accuracy or completeness. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may read this document. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees. Kenanga Investment Bank Berhad accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or any solicitations of an offer to buy or sell any securities. Kenanga Investment Bank Berhad and its associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein from time to time in the open market or otherwise, and may receive brokerage fees or act as principal or agent in dealings with respect to these companies. Published and printed by: KENANGA INVESTMENT BANK BERHAD (15678-H) Level 12, Kenanga Tower, 237, Jalan Tun Razak, 50400 Kuala Lumpur, Malaysia Chan Ken Yew Telephone: (603) 2172 0880 Website: www.kenanga.com.my E-mail: research@kenanga.com.my Head of Research KENANGA INVESTMENT BANK BERHAD (15678-H) Level 12, Kenanga Tower, 237, Jalan Tun Razak, 50400 Kuala Lumpur, Malaysia Chan Ken Yew Telephone: (603) 2172 0880 Website: www.kenanga.com.my E-mail: research@kenanga.com.my Head of Research PP7004/02/2013(031762) Page 5 of 5