On: January 10, 2022 In: Blog, Financial News, Fixed Income

Co-authored by Ng Lee Peng, Head of Investments and Ray Choy, Head of Economics & Research

The global economy continues to recover from the pandemic experienced over the last two years. From a global recession of -3.1% in 2020, the world economy is projected to expand 5.9% in 2021 and 4.9% in 2022 (IMF Oct 21 projection). Risk to growth however remains, from supply chain disruption, inflation and emergence and spread of new variant of Covid-19. The uneven pace of growth, especially between advanced economies and developing economies, may also see different policy measures, where the earlier tightening of policies from advanced economies will cause greater volatility and disruption in financial markets.

In Malaysia, the economic recovery has been slower than anticipated, with the initial expectation of 6.5% – 7.5% growth for 2021, now slashed to only 3% – 4%. This is despite very accommodative fiscal and monetary measures, as longer and stricter lockdown measures have caused a significant slowdown to the recovery. As a result, Malaysia is only expected to fully recover to pre-pandemic economic levels in 2022. Although the resurgence of Covid-19 will continue to pose risk to growth, Malaysia’s high vaccination rate of more than 90% provides some assurance that previous nationwide lockdown measures are unlikely to be repeated. Malaysia is set to benefit from improving external conditions and high commodity prices which would bode well for Malaysia’s trade surplus. Furthermore, the largest Budget on record for 2022 will continue to support the recovery, and focus on social welfare, ESG (environmental, social and governance) projects and the healthcare sector, that came into focus following the pandemic. Fortunately, in Malaysia, the low inflation rate that is projected to remain below 3% in the medium term despite the rise in commodity prices will create conducive conditions for the capital market.

We anticipate the presently accommodative interest rates would support businesses and individuals, while the central bank will continue to ensure liquidity in credit supply for the nascent recovery. Against this backdrop, BNM may consider normalising interest rates upward in the event both inflation and the economic recovery warrant such action. However, the ongoing risk of a recurring pandemic and the tapering of expansionary monetary policy on a global scale will make any decision of a rate hike a difficult one, with potential delays to be likely. However, much of the risk of potential policy tightening is already reflected in the bond market. In 2021, Malaysia’s bond yields, in particular, the Malaysian Government Securities (MGS) have gone up 80 – 100 bps across the curve, resulting in a negative return for the bond market. Much of the reason for the increase in yields was due to rising yields in US Treasuries (UST), as MGS yields track UST closely due to high foreign holdings of MGS. While UST yields rose due to strong growth and high inflation in the US, the Malaysian economy is still slow with manageable inflation. As such, we view the bond market has already priced in the stronger growth and any potential rate hike for next year.

As such, we expect to see a buoyant local bond market going forward despite bouts of volatility in the short term. As real yields on Malaysian bonds remain relatively high given low inflation, the Malaysian bond market is likely to witness continuously moderate inflows of capital from both domestic and foreign investors. Over time, markets will appreciate that inflation in Malaysia is well-managed despite ongoing concerns at the advanced economies where inflation is rising rapidly.
The concerns of heavy bond supply in 2021 and 2022 will continue to weigh on the bond market. However, uncertainties in the economy would encourage investors to seek the safe-haven bond market. With yields already risen 100 bps, we believe higher yields will be capped, and short-term volatility would present opportunities for value in the market. Low-interest rates will continue to spur demand for government bonds, and market volatility arising from the risk of a rate hike will be contained since the economic recovery remains in a nascent stage.

With improving economic conditions we expect to see credit improvement potentially resulting in an environment of stabler credit ratings. This will be accompanied by improving corporate earnings, cash flows, and an ongoing trend of deleveraging. As such, we would see opportunities in the corporate bond market as the economy recovers. In addition, with higher MGS yields, the corporate bond yields will also be higher, presenting opportunities to invest in higher yield papers in a better credit environment. As such we advocate increasing allocation to corporate bonds, and reducing allocation to government bonds, which is still essential to any portfolio as it provides a healthy level of liquidity while providing opportunities to trade as risks are being imputed into yields. At present, the key risk to the bond market is related to interest rate risk and inflation risk. Whether real or perceived, we expect this narrative to remain dominant in the financial markets which will continue to adversely affect sentiment. Therefore, defensive positioning in the bond market could be attained by reducing duration and exposure to volatile investments.


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