Sunday, May 26

“Bullish” to “Neutral”: Malaysian Government Bonds Downgraded

A recent evaluation by DBS Group has downgraded Malaysian government bonds to “neutral” from “bullish”. This evaluation comes after “recent events” in which DBS Group reported that the Malaysian Government Securities (MGS) valuations have risen, in addition to the risks pertaining to performance.

The downgrade comes after the proposed cut of Malaysian bonds after June of this year by Norway’s sovereign wealth fund, “together with nine other emerging market peers, from its benchmark index”. The fund held US$2 billion of Malaysian government bonds, as of the end of 2018.

Additionally, a report by FTSE Russell on 15 April 2019 foresees Malaysia’s current ranking of “2” to be potentially downgraded to a “1”, “which would render Malaysia ineligible for inclusion in the WGBI (World Government Bond Index)”. Malaysia was included in the WGBI in 2004. This ranking by FTSE Russell comes after their published “full Watch List of fixed income markets that will be reviewed for potential changes to their Market Accessibility Levels”.

DBS Group further stated that “passive investors could be holding as much as USD9bn of Malaysian government bonds”.

“In aggregate, USD11bn of potential outflows (expected USD2bn and possible USD9bn) which represents approx. 7% of outstanding and 27% of current foreign holdings”, DBS Group said.

The factors attributed to this downgrade, according to DBS Group, are the weakening of the Malaysian Ringgit against the US Dollar and “some foreign holders unwinding FX hedges alongside their bond sales”.

“Our base case is that Norway’s sovereign wealth fund would sell its holdings in a very gradual manner, to limit market impact and get the best possible price. We also expect Malaysia’s regulators to be in constant engagement with FTSE Russell to address issues and avert an exclusion decision at the September review (we think a retain decision is most likely)”, DBS Group reports.

The group also reported concerns about “elevated uncertainties and risks around future developments and outcomes” that could lead to MGS and the Malaysian Ringgit trading to be “more volatile ahead”. Where MGS valuations are concerned, “there appears to be limited scope for further capital gains”.

“Bank Negara Malaysia’s easing cycle (expected) is likely to be shallow and a cut at the May or July meeting has already been priced in. Earlier in the year, we had expected compression of credit risk premium (as fiscal concerns ease) to drive much of the price appreciation”, the group noted.

Despite the concerns raised by DBS Group, the group remains optimistic in Malaysia’s position being maintained in the WGBI after the September review. The group further noted that “much lower MGS yields are unlikely unless global core yields fall (we expect core yields to be rangebound with slight upward bias)”, even though “the reward-risk proposition of MGS is much less attractive when compared to the start of the year”.

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