Now is time for Malaysian bond investors to increase duration and lock in higher yields

EPF withdrawals to strain financial market liquidity

In end-2020, the Government of Malaysia introduced i-Sinar EPF withdrawal schemes aimed at cushioning the impact of job losses and salary cuts. This however was subject to some stringent measures which include factors such as percentage of reduction in base salary (at least 30%) and staggered disbursement of withdrawals among others. As at January 4th 2021, a total of 3.88 million applications were received, 64% of which has been approved translating into RM19.62¹ billion  in total approved amount. 

Under the new recently announced enhanced i-Sinar scheme, previously imposed criteria have been relaxed. According to estimates, the total i-Sinar programme could see up to RM 56 billion² in withdrawals.

While the withdrawal of EPF monies will put more cash in the hand of consumers, the vacuum of RM 56 billion could strain financial market liquidity. The recent asset sale by EPF across seven states with a total estimated value of RM 350 million to RM 450³ million  provides a glimpse of the need to liquidate assets to meet redemptions from the withdrawal scheme.

In the local bond market, market participants priced in their expectations regarding financial market liquidity in the recent 20Y MGS auction. While the bid-to-cover remained healthy at 2.224 times, the hi-low auction tail of close to 11bps pointed to increased uncertainty in the financial markets. 

^{1 2 3} Source: The Star

Rising inflationary expectations push US yields higher with spillover effects on Malaysian yields

The combined commodity price uptick and USD1.9 trillion COVID-relief stimulus expected to be rolled out in the United States (US) have seen some inflationary pressures rise to the forefront. The faster-than-expected vaccine roll-out in the US coupled with a weather-led disruption in the US oil market in the past week has seen crude oil prices surge beyond the $US65 mark. Given that oil remains a major input for a wide range of sectors, market participants are pricing in a possible reflation. Combined with the USD1.9 trillion stimulus package that will also increase US debt, causing the US Treasury yields to spike, particularly on the longer end (30Y US Treasury), see Chart 1. This phenomenon is known as steepening of yield curve, which indicates that investors are expecting rising inflation and stronger economic growth.

The spill-over effect from recent the spike in US yields saw the local MGS yield spike as Malaysia’s bond market followed suit, albeit on a less steep degree, see Chart 2. While the notion of inflationary pressures in Malaysia remains mute in the near term, the Department of Statistics Malaysia (DOSM) chief statistician Datuk Seri Dr Mohd Uzir Mahidin suggested that inflation may make a comeback on the back of pent up demand, projecting inflation to reach 2.5%, which could have also affected market sentiment.

Chart 1: US Treasury yield across the curve comparison (last traded vs one month ago)

Chart 2: MGS yield across the curve comparison (last traded vs one month ago)

 Consequently, the yield spike has inflicted drawdowns for bond prices, where the BPAM All Bond Index has fallen -1.3% in the past month (24 Jan – 24 Feb 2021). Likewise Malaysian bond funds also saw red across the board, with the 29 bond funds suffering from an average -0.48% loss over the same period, with the higher quality and/or longer duration portfolios suffering the most due to higher interest rate sensitivity, see Chart 3. On the other hand, bond funds with shorter duration and lower rated bonds (with bigger spreads over benchmark rates) managed to weather through better.

Chart 3: Malaysian Bond Funds' 1 Month Performance

Why we think this is an opportunity

We believe yields will stabilise and bond prices recover after this knee jerk reaction due to:

1. Yield seekers to support bonds – Malaysian fixed income has been on the receiving end of global fund inflow. In fact, the first two MGS/GII auctions of 2021 saw over 2 times bid to cover which suggests that demand is still strong, despite the negativity surrounding the Fitch credit rating downgrade. This is due to the fact that Malaysia bonds still offer some of the more attractive yields on a real yield basis and relative basis compared global bond yields. After the recent spike in yields, we foresee yield hungry investors returning which will drive up demand for bonds and consequently support bond prices.

2. Abundant domestic liquidity - Other than demand from global investors, domestic investors are also splash with liquidity especially those fixed depositors looking for higher yields than the current low deposit rates. This could offset the lower demand from EPF due to the i-Sinar outflows.

3.  Low interest rate environment – Given the weak domestic economic backdrop, Bank Negara Malaysia (BNM) is unlikely to raise rates anytime soon with analysts expecting the next rate hike to come only in Q3 2022. That said, whether BNM cuts or not, the low interest rate environment will still be supportive for bonds.

Table 1: Consensus Overnight Policy Rate (OPR) forecast

Source: Bloomberg, iFAST compilations

What can existing Malaysian bond investors do?

Prior to this, with yields and rates at historical lows, we advised investors to shorten the duration of their bond portfolio and look for value in the lower grade / unrated bond segment. Due to the aforementioned reasons, we opine that now is time to take advantage of the recent retracement, to increase duration and lock in higher yields in Malaysia bonds especially in the lower grade / unrated bond segment. 

As a matter of fact, the yields are now back to the levels last seen before the July 2020 Overnight Policy Rate cut. At current yields and spreads, we also believe the downside risk is limited while the upside potential has increased, which means the risk reward for this investment is more attractive now. 

Chart 4: 10-year MGS yield since February 2020

Now is time for Malaysian bond investors to increase duration and lock in higher yields

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