Malaysia FX and rates outlook under focus
The Malaysian ringgit has depreciated into a 4.20-4.25 range. Don’t expect the MYR to buck the weaker Chinese yuan and Singapore dollar, the currencies of its top two trading partners. Despite better-than-expected growth in 2Q19, the finance ministry believed the full brunt of the trade war would be felt only in 2020. The ministry is considering an expansionary budget for 2020 and possibly delay narrowing the fiscal deficit to 3% of GDP next year from 3.4% this year. We are looking for Bank Negara Malaysia to deliver another rate cut in 4Q19. The overnight policy rate was last lowered on May 7 by 25 bps to 3%.
The central bank will further liberalize the foreign exchange administration (FEA) today to improve market liquidity and provide real investors access to hedging onshore. This should help convince FTSE Russell, at its September review, to retain Malaysia in its World Government Bond Index. The new FEA measures will allow businesses to better manage their FX risks and manage daily operations in an increasingly uncertain global environment.
Rates: MGS yields can fall 5-15bps on favourable FTSE Russell decision
FTSE Russell’s review of Malaysia’s Market Accessibility Level, which could have implications on the eligibility of Malaysian Government Securities (MGS) for inclusion in the World Government Bond Index (WGBI), is coming up in September. Various estimates of potential outflows, in the event of an exclusion decision, have largely ranged from USD2bn to USD10bn, depending on underlying assumptions of tracking AUM and investors positioning (extent of overweight/underweight).
In May and August, Bank Negara Malaysia (BNM) have announced a series of measures/initiatives to broaden and deepen the Malaysian financial markets (see link1 andlink2). Some of these directly address FTSE Russell criteria in the areas of bond and FX liquidity, ease and flexibility of FX hedging etc. There has also been active engagement with FTSE Russell to seek feedback. Overall, these efforts appear to be taken quite positively by foreign bond investors. Large outflows post FTSE Russell's announcement in mid-April have reversed in June and July. Our base case is that MGS will stay in the WGBI. A question of interest then, how much can MGS rally if we see a favourable decision.
The year-to-date rally in MGS, alongside regional and global bonds, has masked the pricing of increasing risk premium around the September decision. We think that a good way to estimate that risk premium is to look at the spread between MGS and MYR swaps. Reason being, MYR swaps fix off the 3M Klibor which trades at a very stable spread over BNM policy rates. Ie the 3M Klibor doesn't react much to risk. Charting the spread between 3Y MGS and MYR swaps, we see that the spread has been in a widening trend since mid-April and is currently at -5bps. In the months prior to mid-April, -10 to -15bps seems to be equilibrium range. Therefore, we think MGS yields can fall 5-10bps on a favourable decision, perhaps 15bps if there is some over-reaction.
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