Time To Invest In Bond

The Star Online > Bizweek Saturday October 4, 2008

Malaysian Bond Market

DURING this holiday-shortened week in Malaysia, much has happened in the western countries. In the US, a revised US$700bil rescue package incorporating increase in bank-deposit-insurance limits and tax breaks has been approved by the Senate, and is scheduled to be re-voted by the House of Representatives. Despite the increased possibility of this rescue package being passed, the credit market is getting increasingly jittery. Banks are hesitant to lend to each other, causing spikes in interbank rates which threaten to bring the credit market to a halt.

Warren Buffett summed it up aptly with his statement: “In my adult lifetime I don’t think I’ve ever seen people as fearful, economically, as they are right now ... they are not wrong to be worried.”

With the significant stress in the global credit markets, and the rapidly deteriorating global economic conditions, the Malaysian economy will not be insulated from the turmoil. Falling manufacturing and commodity exports, coupled with slowing domestic consumption due to poor sentiment, mean that we are likely to go through a rough patch in the coming quarters.
In this environment where almost every asset class is falling in value, local bonds especially MGS and high-grade PDS stand out as defensive investments for investors. Cooling inflationary pressure and growing possibility of rate cuts by global central banks mean that not only is unlikely to be raised, but there may be room for rate-cuts going forward. The lack of investment alternatives and improving interest rate outlook provide the upsides for local bonds.
The recent concern of oversupply of MGS following the Government’s revised fiscal deficit target is mitigated by the shrinking PDS issuance pipeline.

Meanwhile, there is still a deep pool of liquidity to underpin the demand for local bonds, with close to RM300bil of excess liquidity in the banking system, and steadily growing pension funds, thanks to our high saving rates. The need to generate real investment return amid the current negative real interest-rate environment should support the buying interest and cap any major downsides of local bonds.

While interest rate and demand & supply conditions bode well for local bonds, the same cannot be said about credit outlook. The impending economic weakness will lead to lower corporate profitability and heightened financial risks €“ two major recipes for higher credit risks. Therefore other than MGS and sovereign-related or supranational credits, investors still need to be very selective on credits in general.

Trading volume is subdued during the week as most market players are away. Nevertheless, the MGS market remains bullish with most benchmark bonds closing 8-10 bps lower. The 3-year benchmark MGS’9/11 contributed bulk of the trades and dipped 10 bps lower to 3.87%, while the 10- and 20-year benchmarks fell 8 and 10 bps to 4.57% and 5.05% respectively. The 5-year benchmark was not traded.

Trading was light in the PDS market, with the bulk of the trades coming from the AAA segment, largely on sovereign-related and supranational credits. Nevertheless, with strong buying interest pushing down MGS and IRS yield curves considerably, credit spreads are now approaching their 5-year highs, raising the prospect of buying interest spilling over to this segment.

MYR Interest Rate Swap

During the week, MYIRS saw better receiving interest on the back of the bullish bond market. As we write, the curve dipped 5-15 bps on week-on-week basis albeit in thin trading. Bullishness in the US bond market on economic concern and expectation of rate cuts supported the local receiving theme as well. We expect to see some volatile movements in MYIRS, tracking bond performance closely in the coming weeks.

US Treasury Market

US Treasuries performed strongly throughout the week as the market was plagued by uncertainties on the US$700bil rescue package. As increasingly the effectiveness of the rescue package is questioned, expectation of rate hikes by the Fed is gaining steam.

The UST yield curve bullish steepened during the week. As at market close on Thursday, yields on the 2 and 5-years UST dropped 48 and 39 bps from last Friday to 1.62% and 2.67% respectively, while the 10 and 30-year UST closed 23 bps and 22 bps lower at 3.63% and 4.15% respectively.

Foreign Exchange Market

Forex movements of late have been largely affected by risk aversion and the US rescue package. During the week, the USD surged against the major currencies on expectation of the approval of the rescue package. We expect more market volatility ahead as nations ponder measures to stabilise the global financial markets.

European currencies fell against the greenback amid growing signs of economic slowdown in Europe. With prospect of recession in the Eurozone and the UK, the outlook for EUR and GBP has turned bearish. We expect a lower trading band of 1.36-1.41 for EUR/USD and 1.74€“1.80 for GBP/USD in the coming weeks.

Yen is firm as risk aversion continues to be the dominant theme. Given the prevailing negative sentiment, USD/JPY is expected to be range-bound within 102€“107 with downside bias.
USD/MYR touched a high of 3.4750 on broad USD strength and the bid tone in the pair will likely persist amid the global financial turmoil. We expect a trading range of 3.4400€“3.4800 in the following week.

Global Economy

Economic data released in the US were largely negative last week. Consumer spending in the US was stagnant in Aug-08, despite a 0.5% m/m gain in personal income as higher income was mainly driven by unemployment insurance and social benefits. In Sept-08, ADP report showed employers cut 8,000 payrolls while Challenger reported a 32.6% y/y increase in job cuts.
Manufacturing activities contracted by the most since 2001 in Sept-08 amid weakened overseas demand. Factory orders fell 4.0% m/m in Aug-08, the most in 2 years. Meanwhile, the housing slump is showing no sign of bottoming, as house prices continued to fall in July-08 by 16-18% y/y.

In Europe, the ECB kept its benchmark interest rate unchanged at 4.25% but signalled the possibility of rate cuts going forward as both growth and inflation were dampened by the credit turmoil.

More pessimistic data were also seen in Asia. In Japan, the Tankan Index showed that large manufacturers turned pessimistic for the first time in 5 years in 3Q08. Japan’s jobless rate rose to a 2-year high of 4.2% in Aug-08. Elsewhere, India and Thailand reported slowing export growth.

CPI readings continued to show cooling price pressures in Asia. In Sept-08, CPI in South Korea and Thailand slowed to 5.1% y/y and 6.0% y/y, from 5.6% and 6.4% a month earlier. Nevertheless, food-price inflation in Thailand was still on an upward trend, increasing 15.7% y/y in Sept-08 vs 14.3% in Aug-08.

For enquiries, please contact:
Ng-juan-hui@ambg.com.my
Melissa-yong@ambg.com.my
Ooi-liang-wu@ambg.com.my
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