Foreign holdings of Malaysian bonds at eight-year low

PETALING JAYA: Foreign holdings of Malaysian bonds fell to an eight-year low last month and selling pressure is expected to continue in the coming months, said Kenanga Research.
It said in a report today that the expected selling pressure is on the back of rising concerns that credit rating agencies would put Malaysia on ratings watch due to the new government's decision to cancel large scale infrastructure projects.
"The implementation of fuel subsidies and the removal of the Goods and Services Tax, which could weigh on the government's ability to meet its fiscal target, are adding pressure to sentiments.
"Additionally, the sudden resignation of Bank Negara Malaysia's (BNM) governor and the changes in several government-linked corporate heads are also expected to add uncertainty to the domestic bond market," it said.
On the external side, rising expectations of an interest rate increase by the US Federal Reserve are seen weighing on regional bond markets. Note that the average Indonesian 10-year bond yield jumped to 7.18% in May while India's average 10-year bond yield has climbed to 7.78%.
Foreigners were net sellers of Malaysian debt securities for the second month in May, with RM12.9 billion sold. This marks the biggest drop in 14 months or since the record RM26.2 billion fall in March 2017.
"The outflow slashed foreign holdings share in Malaysian debt securities to the lowest in eight years (since June 2010) to 14.2%," said Kenanga Research.
It said investor sentiments were rattled by the unprecedented outcome of the 14th general election and the subsequent news flow on Pakatan Harapan's policy decisions.
"External factors were also less encouraging as the US growth indicators point north, suggesting a more hawkish US Fed. Along with rising global trade tensions, demand for emerging market's bonds as a whole weakened in May," it added.
Kenanga Research said the sell-off in May was broad based, across both short-dated and long-dated securities.
Short-dated securities registered the largest outflow in 14 months of RM2.3 billion. The 26.1% decline in foreign fund flows led to foreign holdings of total short-dated Malaysian bonds sliding to 53.9%.
Foreign holdings of long-dated securities (Malaysian government securities/MGS and government investment issue/GII) recorded the largest outflow in 14 months, at RM9.8 billion. As a result, its share slid to 25.9% of total long-dated debt, a 14-month low.
"Consequently, the average local benchmark 10-year MGS bond yields surged to 4.17% in May. Meanwhile, the average yield gap between the benchmark US 10-year Treasury yields and the local 10-year MGS bond yields widened to 120 basis points from 116 basis points the preceding month," Kenanga Research said.
On the brighter side, the issue of the new benchmark 20-year MGS drew good demand, signalling investors' confidence in the long-term outlook of the local bond market.
Kenanga Research expects a gradual relaxation of the foreign exchange administration rules that were implemented during the former BNM governor's time, to lure foreign capital. Hence, it retained its view on capital flight, which is expected to continue in 2H18 before capital flows stabilise.
"As such, we remain optimistic of the long-term capital flow outlook which would provide BNM the flexibility to retain its Overnight Policy Rate at 3.25% to accommodate growth and meet its 5.5-6% economic growth target for this year," it said.