Chart 1

Chart 2

Chart 3

Key Points

• Review of Malaysia bond market
• Inflation should be back to positive growth in 2010
• Bloomberg's survey showed an average inflation rate of 1.98% in 2010
• Possible rate hike in 2H 2010
• We prefer corporate bonds as opposed to government bonds
• Bonds with shorter duration are favoured as they are less sensitive towards rate hike

Review of Malaysia Bond Market

2008 was a good year for bond market, mainly driven by the flight-to-safety theme after the near collapse of the financial systems in major economies like US and Europe. Investors were rushing to buy into government bonds as they are the safest asset amid uncertainties.

As illustrated in chart 1, Malaysia bond market was stable from beginning of 2008 till June 08, with yields on Malaysian government securities (MGS) and private debt securities (PDS) demonstrating a flat trend. However, in mid 2008, inflation spiked up to 8.5%, creating worries among investors. Malaysia bond market, especially government bonds’ prices, went down extensively amidst inflationary fears.

In line with other central banks’ efforts to mitigate impact of a global recession, Bank Negara had cut its benchmark interest rate, Overnight Policy Rate (OPR) by three consecutive times from 3.5% in November 2008 to 2.0% in February 2009. Yields started to trend downwards and prices went up in late 2008 after the equity markets worldwide collapsed. Meanwhile, inflationary pressures receded on falling commodity prices when oil prices slumped from its peak of above USD140 per barrel to USD30-40 per barrel during the period from December 2008 to March 2009. Prices and yields of MGS stabilized since Febuary 2009 as the OPR was maintained at the current level of 2.0%.

Inflation & Interest Rate Movement

Inflation hit a high of 8.5% in the month of July and August 2008 when Malaysia government decided to increase the subsidised petrol price by 40%. Towards the end of 2008, oil price subsided to as low as USD30 per barrel as fear of a global slowdown mounted. The government then lowered the petrol price to the pre-hike level of RM1.80 per litre. Inflation also eased to 4.4% in December 2008. The change in petrol prices introduced significant volatility to inflation numbers. Currently, we’re seeing deflationary scenario in Malaysia’s consumer price index (CPI) since June 2009, mainly due to the higher base effect in the second half of 2008. As at end of October 2009, Malaysia’s CPI was still within the deflationary territory of -1.6%.

Moving forward, we believe the inflation should resume back to positive territory once the higher base effect recedes. In addition, domestic demand could pick up following the economic recovery which will add on to the inflationary pressures. According to Bloomberg’s survey from ten major research houses in Malaysia during the end of November 2009, the average inflation rate in 2010 stood at 1.98%, still below the average inflation rate of 2.84% during the period from 2006 to November 2009.

In its past monetary policy press statements, central bank has emphasized that its priority will be focused on economy recovery instead of combating inflationary pressure. However, along with economy recovery, oil prices could have surprises on the high side. This would bring the actual average inflation rate to rise above the 1.98% estimated inflation rate. With that, we believe that there is great possibility that the central bank would implement rate hike in the second half of 2010 when the economic growth is on the right track. There is a possibility that central bank will execute a 25 basis points rate hike each in the last two meetings to bring the OPR to 2.5%.

The monetary policy committee held eight meetings in 2009 on its key interest rate direction in 2009. In 2010, the number of meetings trimmed to six times and the schedule of the monetary policy committee meetings are as follows:

We Favour Corporate Bonds as Oppose to Government Bonds

Chart 3 illustrated the yields movement for MGS and PDS since January 2008. During the period from November 2008 to January 2009, MGS’s yield declined more as compared to PDS with credit ratings of AAA and BBB, largely reflecting the changes on the overnight rate and investors’ preference for risk-free assets or “flight-to-safely”.

In anticipation of rate hike, we favour corporate bonds as opposed to government bonds. We believe that rate hike impact on the MGS will be greater as opposed to PDS. This is not only due to the MGS being more sensitive towards rate changes, but also attributed to the higher risk appetite amongst investors and the higher yields provided by PDS.

We prefer Bonds with Lower Duration

Duration is a measure of sensitivity of a bond towards interest rate changes. Bond duration is measured by number of years. If a bond has a duration of 5 years, this means that if the interest rate increase by 1%, the bond price will fall by 5%, vice versa. Hence, if comparing two bonds with different durations, say Bond A has a duration of 2 years while Bond B has a duration of 5 years. If interest rate increases by 1%, investors who hold Bond A is better off than investors who hold Bond B as the price fluctuation in Bond B is greater. As we anticipate rate hikes in the second half of 2010, we prefer bonds with lower duration as they are less sensitive towards rate hikes.

In conclusion, we expect key interest rate hike in the second half of 2010. In order to position ourselves towards the possible rate hike, we recommend investors to invest into corporate bonds as opposed to government securities while holding bonds with shorter duration couldl mitigate the impact of possible rate hikes as well.

Investors are advised to monitor the updates from fund factsheets on a regular basis to check on the shift in investment strategy of fund management companies on their underlying holdings of bonds.

In addition, investors are also able to obtain some updates on bond information such as net yield to maturity, average duration and average credit rating in our website.

RELATED LINKS:
Net Yield To Maturity Info
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Interpreting Yields for Bond Funds
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