Malaysia’s bonds have been the star performers in emerging Asia this quarter thanks to a succession of interest-rate cuts. Stubborn deflation and a shrinking economy mean there may be more to come.
Traders are betting Bank Negara Malaysia will lower borrowing costs for a fifth straight meeting in September after reducing its benchmark by a combined 125 basis points this year. Other positives powering the bond rally include a surge in foreign inflows and among the highest real yields in the region.
“It’s not clear that there is necessarily a hard floor for the policy rate in Malaysia,” said Brian Tan, a regional economist at Barclays Bank in Singapore. In addition to the sharp contraction in GDP, “the resurgence of Covid-19 in Malaysia’s key export markets such as the U.S. threatens to hamstring external demand,” he said.
Ringgit government bonds have returned more than 5% since the start of July, far outpacing their nearest competitors, the Philippines and South Korea. Malaysia’s benchmark three-year yields have fallen almost 40 basis points over the period after dropping by 75 basis points in the first half of the year.
This quarter’s outperformance has been driven by the central bank’s July 7 meeting, when policy makers cut rates to a record-low 1.75% and warned of further downside risks from the coronavirus crisis. Three-year swap rates have fallen to around 10 basis points above the central bank’s benchmark, close to levels seen before previous policy decisions that led to rate cuts.
Malaysia’s economy shrank 17.1% last quarter from a year earlier, the biggest drop since the Asian financial crisis in 1998, the central bank said Friday. The decline exceeded the median forecast of a 10.9% contraction in a Bloomberg survey.
Despite the bleak outlook, global funds have been pouring into Malaysia’s debt. Net foreign inflows totaled $4 billion in the three months through July, coming close to erasing the cumulative outflow of $4.7 billion in the previous three months that was caused by the Covid-19 outbreak.
One of the key attractions for overseas investors is the nation’s relatively high real yields, which are being bumped up by a four-month bout of deflation. Malaysia’s 10-year bonds offer a current nominal yield of 2.49%, which translates into a real yield of 4.39% when the most recent CPI reading is taken into account.
“In a yield-starved environment, the high-yielding appeal of emerging Asia including ringgit bonds should continue to attract inflows, as long as the global risk sentiment remains conducive,” said Winson Phoon, head of fixed-income research at Maybank Kim Eng Securities in Singapore.
With the level of bond yields in many emerging markets closing in on record lows, holders of Malaysia’s debt can feel quite content. Expected foreign inflows and deflation are both positives, while the central bank looks set to provide the perfect backstop.
What to Watch
- Thailand will release second-quarter GDP on Monday, which will give an insight into the full impact of the coronavirus lockdown
- Bank Indonesia is scheduled to set its policy decision Wednesday, after cutting rates at its two previous meetings. Policy makers in the Philippines are forecast to keep rates on hold when they meet Thursday
- Malaysia will publish headline inflation data on Friday, with the nation having experienced deflation every month since March
Note: Marcus Wong is an EM macro strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice.
