The Tapering Anxiety - MARC
Transcript of The Tapering Anxiety - MARC
January 13, 2014 www.marc.com.my
2014 Bond Market Outlook
The Tapering Anxiety
Fixed Income Research KDN PP 16084/10/2012 (030859)
MALAYSIAN RATING CORPORATION BERHAD (364803 V)
Economic and Fixed Income Research Department
Nick Lee Chin Fah Afiq Akmal Mohamad Fixed Income Analyst Economic Analyst [email protected] [email protected]
Nor Zahidi Alias Nurhisham Hussein Chief Economist Economist [email protected] [email protected]
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 2
Executive Summary
Remarks by the United States (US) Federal Reserve’s (Fed) Chairman on the possibility of a
tapering in bond purchases since May 2013 and the decision to scale back in December Federal
Open Market Committee (FOMC) meeting have pushed up US Treasury (UST) yields significantly. In
response, global sovereign bond yields also spiked up as anticipations of a reduction in bond purchases
heightened. Yields of the benchmark 10-year UST note surged to around 3% level by end of December,
compared with its recent trough of 1.63% in May 2013. Going forward, we foresee bond purchases to be
trimmed at a measured pace by the Fed due to (1) the inflation rate as measured by personal consumption
expenditure price index (PCE) of 0.9% in November, which is well below the Fed‟s target of 2.0% and is
expected to remain benign in the foreseeable future, giving flexibility to the Fed to maintain some degree of
stimulus to further support the economic recovery; (2) the US housing sector which may be threatened if
interest rates were to rise rapidly; (3) the “dovish” remarks by Janet Yellen, the incoming chairwoman of the
Fed who showed strong support for Quantitative Easing (QE) 3 by stating that asset purchases are needed
to promote a more robust economy and a reduction of the stimulus policy can only be undertaken when the
US economy and labour market show sustainable improvements.
The euro zone economy will continue to expand at a sub-par level with some downside risks and
hence German Bunds will likely outperform the UST. Deflationary risk and a nascent economic
recovery will likely induce the European Central Bank (ECB) to maintain the benchmark refinancing rate at
a record low of 0.25% for the foreseeable future. In addition, the ECB may unveil additional long-term
refinancing operations in light of rising money market rates and the strong euro which could slow down the
pace of economic recovery. With the expectation of the ECB maintaining near-zero interest rates and a
tepid recovery in the euro zone economy coupled with the tapering plan by the Fed, German Bunds should
continue to outperform UST with yield spreads continuing to widen in the year ahead.
In the United Kingdom (UK), Gilts will closely track the performance of the UST as the UK economy
continues to outperform other European economies judging by latest data releases especially on
the labour market and housing sector performances. The Bank of England‟s (BoE) latest forecast of a
more rapid decline in the unemployment rate to the 7% threshold by mid-2015 rather than by late 2016
could mean that the central bank may tighten its monetary policy earlier than expected. In addition, a strong
correlation between the US and the UK financial market leaves UK Gilts open to risks of tapering by the
Fed. All in all, we see UK sovereign bond yields to trend upward by almost a similar pace as UST in 2014.
Malaysia’s relatively open financial market means the Fed’s tapering will add to the volatility of the
ringgit and the bond market. This is evidenced by the local currency market where the ringgit has been
sensitive to the Fed‟s tapering plan, weakening by as much as 8.3% to RM3.33 against the USD in August
as foreign investors trimmed their holdings of Malaysian Government Securities (MGS), leading to the
biggest loss since 2008. In addition, the responsiveness of Malaysia‟s Credit Default Swap (CDS) market to
external news implies that investors would continue to keep an eye on developments related to the Fed‟s
monetary stance.
Narrowing yield spreads with sovereign bonds of advanced economies will slightly dampen the
demand for MGS. Given rising yields in the major developed countries, sovereign yield spreads of MGS
against other major sovereign bonds are narrowing, reducing investor appetite for MGS as they shift their
interest to major sovereign bonds which are now offering rising yields. Compared to the widest sovereign
spread of 173 basis points (bps) between the benchmark 10-year MGS and UST yields in early April 2013,
the spread has narrowed by 62 bps to 111 bps on 24 December. Similarly, sovereign yield spreads
between MGS and UK Gilts have continued to tighten, increasing the risks of further foreign capital outflows
from Malaysia.
Malaysia’s high household debt is among key economic concerns for the local bond market. The
elevated level of household debt is among the concerns which could amplify the country‟s credit risk. Thus
far, the risk of Malaysia‟s household debt has been mitigated by high household financial assets and low
interest rates. Nonetheless, things may change after the Fed starts to scale back its asset purchases and
the domestic economy reacts to higher inflation in 2014. The concern is that emerging markets – Malaysia
included – may have to raise their benchmark interest rates which make the sustainability of high debt
questionable. This is negative for the bond market.
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 3
Slowing regional economic growth is another potential risk. A persistent slowdown in China‟s economy
– the world‟s second largest economy and one of Malaysia‟s top trading partners – will exert additional
pressure on Malaysian financial market and dent investor enthusiasm for MGS against regional sovereign
bonds. A slowdown in India‟s economy is also another concern as the country is an important trading
partner for many Asian nations. In Thailand, the ongoing political turmoil arising from efforts to depose the
present Prime Minister is also weakening its domestic economy, causing the government to downgrade its
growth forecast for 2014. Such negative sentiments in the regional economies, should they prolong, will not
augur well for Malaysia‟s external sector and will affect the country‟s headline growth, causing foreign
portfolio investors to sideline MGS.
Notwithstanding this, there are still factors that will support the MGS market, one of which is the
persistently positive real interest rates and relatively attractive real yields. Although the inflation rate
has picked up since the 2H2013 following a resumption of the government‟s subsidy rationalisation effort,
we do not foresee it to cause real interest rates to turn negative as we anticipate a marginal increase in the
level of the Overnight Policy Rate (OPR) in 2014. In addition, from the perspective of real bond yields, MGS
remain more attractive when compared to sovereign bonds of major advanced and selected regional
countries due to Malaysia‟s relatively low inflation environment.
Another plus point is the federal government’s miniscule external debt and high level of
international reserves which will insulate Malaysia from the impact of capital outflows. Despite the
relatively high total government debt-to-gross domestic product (GDP) ratio, the federal government‟s
external debt remains minuscule, accounting for only 3.2% of total government debt in the 3Q2013.
Meanwhile, Bank Negara Malaysia‟s (BNM) international reserves have increased to RM440.8 billion or
USD135.3 billion as of mid-December 2013 from RM331.3 billion in 2009, which were sufficient to finance
9.4 months of retained imports and were 3.7 times of short-term external debt. The relatively high level of
international reserves will provide a sufficient buffer should there be a rapid withdrawal of foreign capital
from the country.
All in all, we are of the view that long-term foreign investors will continue to support government
papers in the near term. We continue to believe that foreign investors with long-term investment
perspectives (such as sovereign wealth funds, insurance companies, central banks etc) will not totally
abandon local govvies as they are less influenced by changes in the Fed‟s monetary policy stance and tend
to focus more on Malaysia‟s long-term economic fundamentals. Furthermore, domestic institutional
investors will continue to provide their support to the local financial market. This is evidenced from the
growing investible fund size of institutions such as the Employees Provident Fund (EPF), Retirement Fund
Incorporated (KWAP), unit trusts, insurance and Takaful as well as the strong demand for BNM‟s inaugural
30-year note.
We maintain our view of an upside bias for MGS yields and expect the yield curve to steepen further.
This is premised on further improvements in the US economy and labour market which would warrant the
US Fed to continue its tapering plan at a measured pace in 2014. In addition, a slow but steady recovery of
other advanced economies such as the euro zone and Japan would lead to further expectations of capital
outflows from this region – Malaysia included – despite providing a reasonable support to Malaysia‟s
headline GDP growth. On the local front, stronger Consumer Price Index (CPI) growth especially in the
2H2014 on the back of the resumption of the subsidy rationalisation plan and the rollout of the Goods and
Services Tax (GST) in April 2015 will result in higher bond yields following a 25 bps hike in the OPR which
we think will be undertaken by BNM in order to be ahead of the curve to manage higher consumer prices
and possible capital outflows in 2014.
We forecast lower Malaysian government bond issuance amid the government’s effort to gradually
reduce budget deficits. Assuming the budget deficits of RM37.1 billion and RM46.9 billion worth of
MGS/Government Investment Issues (GII) projected to mature in 2014, we expect the Malaysian
government bond issuance to come in at between RM85 billion and RM90 billion. Meanwhile, based on the
2014 MGS/GII issuance calendar announced by BNM recently, there will be a total of 16 auctions for MGS,
12 auctions for GII and 4 auctions for Sukuk Perumahan Kerajaan (SPK), thus raising the auction ratio of
GII-to-MGS to 43:57 from 23:77 in 2008.
As for corporate bonds, we foresee the total issuance in 2014 to moderate slightly when compared
to 2013. Given the government‟s elevated debt level and rapid increases in contingent liabilities, we
foresee less leeway for the government to guarantee future debt. Furthermore, expectations of a
moderation in the overall domestic economy as well as uncertainties over the speed of the US Fed tapering
of bond purchases will likely cause gross corporate bond issuance to moderate slightly to between RM65
billion and RM75 billion in 2014.
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 4
We do not foresee broad-based credit deterioration in 2014 although profit margin for corporate
may continue to drag. Judging from the weighted average profit margin of constituents in the FTSE Emas
Index, profitability of the Malaysian companies has moderated to 13.3% as of 27 December compared to
13.8% in 2012. In addition, the leverage levels of the companies under coverage have increased,
evidenced by their increasing total debt-to-total assets ratio to 19.1% as of 27 December (2012: 18.2%).
We are of the view the lower profit margin is mainly due to uncertainties in the external environment as well
as slowing economic growth regionally. Notwithstanding this, we think that corporate earnings have
generally remained stable and that there are no serious concerns regarding overall credit quality. We do not
see broad-based credit deterioration in 2014 due to respectable headline economic growth of circa 5%,
supported by relatively strong private investment and resilient private consumption growth, albeit slower
than in 2013. Our view is that any negative rating will mainly be issuer or sector related.
Based on our rating universe, we continue to see the downgrade-to-upgrade ratio to stay above one
in 2014. The industrial product sector continues to dominate the negative rating actions with its sub-
component, the steel sector, facing depleting margins amidst overcapacity of steel production in China
coupled with softening steel prices. In addition, although we do not anticipate a significant downgrade risk
from the property sector, a slew of cooling measures announced by the government and BNM to rein in
rising house prices could exert downward pressure on property companies‟ profitability, dampening the
sector‟s outlook.
We also maintain an upside bias for private debt securities (PDS) yields. Nonetheless, we expect the
magnitude of increases in corporate bond yields to be smaller than those of MGS, thus narrowing the
corporate yield spread as corporate bonds are less sensitive to external shocks amid low foreign holdings.
In the primary market, investment grade bonds will likely continue to dominate the local bond origination
market while activities for those rated BBB and below will remain lackluster due to wide yield spreads.
Exhibit 1: Timeline of major events in 2013
Source: Bloomberg, MARC Fixed Income Research
1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
3.1
2.9
3.0
3.1
3.2
3.3
3.4
MYR/USD (LHS) 10Y UST (RHS)MYR/USD %
GE13
Tapering hints
No taperingsurprise
US debt ceiling crisis
Malaysia's Budget 2014
Taperingannounced
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 5
Investors reacted to
Bernanke’s statement on the
possibility of a cutback in
bond purchases in May 2013
Market experienced another
sell-off after June’s FOMC
when Bernanke reiterated
Fed’s intention
But the tone from the Fed
changed by mid-July
Speculation on tapering
resumed in September
Bond market also reacted to
the unexpected 16-day
partial government closure in
October
The Fed unexpectedly
refrained from tapering in
October’s FOMC
By November, the economy
improved further with jobless
rate falling to a 5-year low
The tapering announcement
finally happened in
December
The US Treasury Market
A quick review On 22 May 2013, Ben Bernanke, chairman of the US Fed, hinted to the world that the
central bank is considering scaling back its USD85 billion monthly bond purchases
programme in light of the strengthening job market, a sign of increasing momentum in
economic recovery. Investors immediately reacted to the news by reducing their
holdings of UST in fear of rising yields, pushing the benchmark 10-year UST note yield
to close at 2.04% on that day from 1.63% earlier in the month. The tapering headlines
did not stop there.
The UST market experienced another sell-off after the FOMC meeting in June when
Bernanke reiterated the Fed‟s intention to taper bond purchases and to end it entirely by
mid-2014 given that the economy is finally achieving sustainable growth. During the
meeting, the FOMC emphasised that “the pace, composition, and extent of asset
purchases would continue to be dependent on the Committee‟s assessment of incoming
information for the economic outlook… as well as the economic objectives…”. However,
in his testimony to the House Financial Services Committee in mid-July, Bernanke
stated that the asset purchase programme is highly data-dependent and commented
that the Fed will keep monetary policy accommodative for the foreseeable future given
the PCE inflation rate that was lower than the policymakers‟ 2.0% target and a
persistently high unemployment rate. Since then, the UST market became highly
sensitive to every economic report released, especially those that have a direct impact
on the Fed‟s tapering decision.
The yield for the benchmark 10-year UST notes surged to almost 3.0% in early
September on speculation that the Fed would announce a reduction in bond purchases
after its October FOMC meeting. However, a partial government closure which lasted for
16 days in early October prevented UST yields from rising further. The incident, which
led to furloughs of approximately 800,000 government servants, was finally resolved
when the US Congress reached a last-minute agreement after weeks of standoff, putting
an end to the partial government shutdown and preventing a government default. It was
then agreed that federal agencies would be funded until 15 January 2014 and the debt
ceiling would be suspended until 7 February 2014. Many investors viewed this action as
a temporary stop-gap measure, as the issue is bound to hit the country again in the
coming months.
In the October FOMC meeting, the Fed unexpectedly held its asset purchases intact at
USD85 billion per month, citing that it needed more signs of a sustained recovery and
warning that a hike in interest rates could threaten the country‟s fragile economic
growth. As a result, uncertainties over the Fed‟s tapering decision started to take a toll
on investor sentiment and led to a more volatile market, causing a bearish steepening of
the UST yield curve with the UST 10/5 yield spread widening to 143 bps in late
November, the widest spread for the year and compared to the daily average at about
117 bps in 2013.
By November, economic conditions improved further with the unemployment rate
dropping to a five-year low of 7.0% compared to 8.1% in September 2012, when the
third round of quantitative easing began. About 2.8 million jobs were created over the
same period and the unemployment rate moved closer to the Fed‟s threshold target of
6.5% as stated in its forward guidance policy. The latest unemployment rate also
matched the 7.0% requirement to deliberate an end to the bond purchases programme.
Tapering finally became a reality after the December FOMC meeting when the Fed
outlined its first cutback plan in monthly bond purchases by USD10 billion to USD75
billion starting January 2014. While the Fed‟s move partly eased jitters in the global
bond market, the focus has now shifted to the pace of tapering in the near future. A
rapid move to further trim monthly purchases would signal the Fed‟s confidence about
the recovery, leading to more „blood in the street‟.
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 6
We foresee the Fed to scale
back its monthly bond
purchases at a measured
pace
Prospects for 2014: A measured pace of future tapering
We are of the view that the Fed will scale back its bond purchases at a measured pace
due to several reasons. First, the inflation rate as measured by PCE of 0.9% in
November is well below the Fed‟s target of 2.0% and has been trending downward since
2012. Inflation is expected to remain benign in the foreseeable future, giving flexibility to
the Fed to maintain some degree of stimulus to further support the economic recovery.
Secondly, the US housing sector could be threatened by rapid increases in interest
rates. According to the National Association of Realtors, pending home sales in the US
fell by 0.6% in October due to rising property prices and higher mortgage rates following
the Fed‟s tapering announcements. This may prevent policymakers from hastily carrying
out further tapering actions. In addition, Janet Yellen, the incoming chairwoman of the
Fed showed her support for QE3 in her confirmation hearing on 14 November by
commenting that asset purchases are needed to promote a more robust economy and a
reduction of the stimulus policy can only be undertaken when the US economy and
labour market show sustainable improvements.
Exhibit 2: UST yield curve steepened in response to the Fed’s tapering
Source: Bloomberg, MARC Fixed Income Research
Exhibit 3: UST 10/5 yield spreads widening
Source: Bloomberg, MARC Fixed Income Research
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2y 3y 5y 7y 10y 30y
% End-2012 Jun-13
Sep-13 End-2013
UST yield curve bearish steepened with right tail of the cuve shifting higher than left tail
90
100
110
120
130
140
150
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5% UST 10/5 (bps, RHS)
UST 10Y (%, LHS)UST 5Y (%, LHS)
bps
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 7
Exhibit 4: UST 10/5 yield spreads hit its highest level in November
Source: Bloomberg, MARC Fixed Income Research
Exhibit 5: US unemployment rate is moving closer to Fed’s threshold target
Source: Bloomberg, MARC Fixed Income Research
Exhibit 6: CPI and PCE inflation are well below the Fed’s target
Source: CEIC, MARC Fixed Income Research
90
100
110
120
130
140
150bps UST 10/5
+1 SD
-1 SD
Mean
UST yield curve steepened with 10/5 yield spread hitting its
highest level in November
4.5
5.5
6.5
7.5
8.5
9.5
10.5-1,000
-800
-600
-400
-200
0
200
400
Jan
-08
Ap
r-0
8
Jul-
08
Oct
-08
Jan
-09
Ap
r-0
9
Jul-
09
Oct
-09
Jan
-10
Ap
r-1
0
Jul-
10
Oct
-10
Jan
-11
Ap
r-1
1
Jul-
11
Oct
-11
Jan
-12
Ap
r-1
2
Jul-
12
Oct
-12
Jan
-13
Ap
r-1
3
Jul-
13
Oct
-13
'000 Change in nonfarm payrolls 3-mma ('000, LHS)Unemployment rate - Inverted Scale (%, RHS) %
Fed's threshold target at
6.5% unemployment rate
QE1 QE2 QE3
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Jan-
08
Apr
-08
Jul-0
8
Oct
-08
Jan-
09
Apr
-09
Jul-0
9
Oct
-09
Jan-
10
Apr
-10
Jul-1
0
Oct
-10
Jan-
11
Apr
-11
Jul-1
1
Oct
-11
Jan-
12
Apr
-12
Jul-1
2
Oct
-12
Jan-
13
Apr
-13
Jul-1
3
Oct
-13
CPI (% y-o-y) PCE Inflation (% y-o-y)
Fed's PCE inflation target at 2.0%
%
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 8
Contrary to the Fed, ECB
slashed its key rate twice in
2013
Exhibit 7: A drop in pending home sales index is among the reasons for the Fed to scale back at a gradual pace
Source: Bloomberg, MARC Fixed Income Research
Euro Zone and UK Sovereign Bond Market
A quick review Unlike the US Fed, which pledged to reduce its unprecedented stimulus once the
country‟s economy and labour market improve at a sustainable pace, Mario Draghi,
president of the ECB slashed key interest rates twice in 2013. The Refi rate was
reduced to a record low of 0.25% from 0.75% in a 25 bps cut each in the months of May
and November, in view of the strong euro currency and high deflation risk which have
taken their toll on the region‟s economic recovery. As a result, although fears of the
Fed‟s tapering pushed the benchmark 10-year German Bund yields higher by about 61
bps to 1.92% in December from the previous year‟s 1.32%, yields did not spike as much
as of the 10-year UST which surged more than 100 bps. As a result, the spread of these
two sovereign bonds widened to about 110 bps in December, the widest since mid-
2006.
Exhibit 8: 10-year UST/Bund spread widest since mid-2006
Source: Bloomberg, MARC Fixed Income Research
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
Jan
-12
Feb
-12
Mar
-12
Ap
r-1
2
May
-12
Jun
-12
Jul-
12
Au
g-1
2
Sep
-12
Oct
-12
No
v-1
2
De
c-1
2
Jan
-13
Feb
-13
Mar
-13
Ap
r-1
3
May
-13
Jun
-13
Jul-
13
Au
g-1
3
Sep
-13
Oct
-13
Pending Home Sales (% m-o-m)%
-100
-50
0
50
100
150
Jan-
06
Jun-
06
Nov
-06
Apr
-07
Sep-
07
Feb-
08
Jul-0
8
Dec
-08
May
-09
Oct
-09
Mar
-10
Aug
-10
Jan-
11
Jun-
11
Nov
-11
Apr
-12
Sep-
12
Feb-
13
Jul-1
3
Dec
-13
bps 10Y UST/Bund Spread
-1 SD
Mean
Widest spread since mid
2006
+1 SD
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 9
Macro developments
remained a concern as the
rising euro threatened export
and growth performance
\
BOE maintained its policy
rate at 0.5%
And the UK economy has
been recovering at a steadier
pace while the labour market
is strengthening
Yields for UK Gilts rose by
more than one-percentage
point
Macro developments in the euro zone justified the jitters in the financial markets. In
particular, headline CPI grew by a mere 0.9% in November, well below the ECB‟s target
rate of circa 2.0%. Meanwhile, the strengthening of the euro currency by as much as
4.1% year-on-year against the USD also threatened the region‟s exports, exerting more
pressure on the region‟s fragile economic recovery. The latest data in the 3Q2013
showed that the euro zone‟s GDP posted an anemic growth of 0.1%, as the economy
was dragged down by contractions in France and Italy and slower growth in Germany.
Furthermore, the unemployment rate remained stubbornly elevated and hit a historical
high of 12.2% in September, albeit declining slightly to 12.1% in October, bringing the
total number of unemployed people to 19.3 million.
In the UK, the new governor of the BoE unveiled the central bank‟s forward guidance
policy in August in which it promised not to raise the key interest rate from its current
level of 0.5% until the unemployment rate falls to 7.0%. He also added three other
conditions: inflation of not more than 2.5%, medium-term inflation expectations under
control and that unconventional monetary policy does not significantly threaten financial
system stability.
Meanwhile, the country‟s economy is recovering at a steadier pace than its euro-area
neighbours with GDP growing by 0.8% in the 3Q2013 after expanding 0.7% in the
2Q2013, giving a reason for the BoE not to trim the key rate further. Similarly, the UK
labour market is strengthening, with September‟s unemployment rate falling to 7.6%, the
lowest level since 2009. The improvement is also evidenced from payroll numbers which
showed an increase to a record 30 million people during the same period, leading the
BoE to believe that the unemployment rate may decline to 7.0%, the threshold for
considering an increase in the key rate by the 3Q2015, almost a year earlier than
previously forecasted. In the bond market, similar to developments in the UST market,
the yield for the benchmark 10-year UK Gilts had increased by more than one
percentage point by end-December 2013 to 3.02%, compared to 1.83% in the
corresponding period in 2012.
Exhibit 9: ECB Refi, BOE rates, EUR, GBP, Bund and Gilt – 2013 vs. 2012
Source: Bloomberg, BNM, MARC Fixed Income Research
Euro Rates Dec-13 Dec-12 Change
ECB Refinancing Rate 0.25 0.75 -50 bps
EUR 1.37 1.32 4.17%
2-year Bund 0.21 -0.02 23 bps
5-year Bund 0.92 0.30 63 bps
10-year Bund 1.93 1.32 61 bps
30-year Bund 2.76 2.18 58 bps
UK Rates Dec-13 Dec-12 Change
Bank of England Official Rate 0.50 0.50 unchange
GBP 1.66 1.63 1.86%
2-year UK Gilt 0.56 0.32 24 bps
5-year UK Gilt 1.86 0.86 100 bps
10-year UK Gilt 3.02 1.83 119 bps
30-year UK Gilt 3.67 3.10 56 bps
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 10
Euro zone economy to grow
at sub-par level despite
Germany’s respectable
performance
We are of the view that
ECB’s accommodative
action will prevail in the near
term
Exhibit 10: Euro area and UK GDP since 2008
Source: Bloomberg, BNM, MARC Fixed Income Research
Exhibit 11: 10-year Italy, Spanish and France government bond yields
Source: Bloomberg, MARC Fixed Income Research
Prospects for 2014: Slower recovery in the euro zone while Germany and UK will outperform peers For 2014, we continue to believe that the euro zone economy will continue to expand at
a sub-par level with some downside risks. This is despite the favourable performance of
the euro zone‟s largest economy, Germany, which saw the export sector benefitting
from the recovery of the global economy. Germany also experienced an unemployment
rate of 5.2%, less than half of jobless rate in the euro zone as a whole.
All in all, we are still of the view that the region‟s deflationary risk and nascent economic
recovery will likely induce the ECB to maintain interest rates low by pegging its
benchmark refinancing rate at a record low of 0.25% for the foreseeable future. In
addition, the ECB may unveil additional long-term refinancing operations in light of rising
money market rates and the strong euro currency which could slow down the pace of
economic recovery. As for the labour market, we expect that slow recovery in 2014 will
keep the unemployment rate at its current high levels of between 11.5% and 12.0%.
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
Euro Area 17 (% y-o-y) German (% y-o-y)
Italy (% y-o-y) France (% y-o-y)
UK (% y-o-y)
%
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Jan-
11
May
-11
Sep-
11
Jan-
12
May
-12
Sep-
12
Jan-
13
May
-13
Sep-
13
%Italy 10Y Yield (%)Spanish 10Y Yield (%)France 10Y Yield (%)
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 11
German Bunds should
continue to outperform the
UST
Better prospects for the UK
and yields for UK Gilts to
trend upward at an almost
the similar pace as UST
Exhibit 12: Euro zone unemployment hit a record high in Sep-2013
Source: CEIC, MARC Fixed Income Research
With the expectations of the ECB maintaining low interest rates and a tepid recovery in
the euro zone economy coupled with the tapering plan by the US Fed amid signs of
sustainable economic growth, German Bunds should continue to outperform UST with
yield spreads continuing to widen in the year ahead.
As for the UK, the recent upgrade in its growth forecast for 2014 by the International
Monetary Fund (IMF) indicates better prospects for the economy in the near term. The
fact that the BoE now expects the declining unemployment rate to hit the 7% threshold
by mid-2015 rather than by late 2016 as forecasted earlier could mean that the central
bank may tighten its monetary policy earlier than expected. In addition, a strong
correlation between the US and UK financial markets leaves UK Gilts open to the risks
of tapering by the Fed. All in all, we see UK sovereign bonds yields to trend upward at
an almost similar pace as UST in 2014.
Exhibit 13: UK Gilts to track UST closely while Bunds will outperform
Source: Bloomberg, MARC Fixed Income Research
0.0
5.0
10.0
15.0
20.0
25.0
30.0%
Euro Area 17 Austria Germany
Italy Portugal Spain
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Jan-
11
May
-11
Sep-
11
Jan-
12
May
-12
Sep-
12
Jan-
13
May
-13
Sep-
13
% UST 10Y Bund 10Y Gilt 10Y
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 12
Government bond issuance
matched our earlier
projection in 2013
We expect MGS/GII
issuance at between RM85
billion and RM90 billion in
2014
With ratio of MGS-to-GII to
narrow further
The Malaysian Government Bond Market
Government bond issuance For the year 2013, the government raised a total of RM92.5 billion from 27 debt auctions, matching our earlier projection of RM90 – RM95 billion, of which about 56% or RM51.5 billion were offered via the MGS market while the remaining were from the GII market. Meanwhile, the government also issued two SPK during the year, raising funds worth RM4.4 billion. As expected, the funds raised were less when compared to the previous year‟s RM96.2 billion amid the government‟s efforts to gradually reduce the country‟s budget deficit to 4% of GDP in 2013, and to a further 3% of GDP by 2015. Assuming the budget deficits of RM37.1 billion in 2014 and RM46.9 billion worth of MGS/GII projected to mature in 2014, we expect MGS/GII bond issuance to come in at between RM85 billion and RM90 billion. Based on the 2014 MGS/GII issuance calendar announced by BNM recently, there will be a total of 16 auctions for MGS, 12 auctions for GII and 4 auctions for SPK.
Exhibit 14: MGS / GII auction result for 2013
Source: FAST, MARC Fixed Income Research
Exhibit 15: SPK auction result for 2013
Source: FAST, MARC Fixed Income Research
Looking at the composition profile, consistent with the government‟s objective to
promote the Islamic capital market, the auction ratio of GII-to-MGS has risen rapidly over
the past years and to hit 43:57 in 2014 from 23:77 in 2008. To attract more investors
who are seeking Shariah-compliant assets, it will not be surprising if the government
continues to increase its GII issuance in the coming year, bringing the issuance of GII-
to-MGS to an equal ratio of 50:50 in the near future.
IssuesTenure
(Years)
Target
QuarterTarget Month
Issue
Date
Amount
(RM Mil)
Bid-To-Cover ratio
(x)Average Yield (%)
7-year Re-opening of GII 05/20 3.576% 7 1Q2013 January 08-Jan-13 3,500 2.35 3.49
3.5-year New Issue of MGS (Mat on 07/16) 3 1Q2013 January 15-Jan-13 4,500 2.49 3.17
15.5-year New Issue of GII (Mat on 08/28) 15 1Q2013 February 08-Feb-13 3,000 2.22 3.87
3-year Re-opening of GII 02/16 3.235% 3 1Q2013 February 25-Feb-13 3,500 2.03 3.17
5-year New Issue of MGS (Mat on 03/18) 5 1Q2013 March 01-Mar-13 4,500 1.94 3.26
10-year New Issue of MGS (Mat on 03/23) 10 1Q2013 March 15-Mar-13 4,500 1.65 3.48
7-year Re-opening of MGS 03/20 3.492% 7 2Q2013 April 04-Apr-13 3,500 1.64 3.42
20-year New Issue of MGS (Mat on 04/33) 20 2Q2013 April 15-Apr-13 2,500 2.88 3.84
10.5-year New Issue of GII (Mat on 10/23) 10 2Q2013 April 30-Apr-13 4,000 2.20 3.49
3-year Re-opening of MGS (Mat on 07/16) 3 2Q2013 May 15-May-13 3,500 1.56 2.93
5.5-year New Issue of GII (Mat on 11/18) 5 2Q2013 May 31-May-13 4,000 1.91 3.40
15-year New Issue of MGS (Mat on 06/28) 15 2Q2013 June 14-Jun-13 3,000 1.57 3.73
7-year Re-opening of GII 05/20 3.576% 7 2Q2013 June 28-Jun-13 4,000 1.90 3.75
10-year Re-opening of MGS (Mat on 03/23) 10 3Q2013 July 15-Jul-13 3,500 1.73 3.70
3-year New Issue of GII (Mat on 07/16) 3 3Q2013 July 22-Jul-13 4,000 2.92 3.39
7-year New Issue of MGS (Mat on 07/20) 7 3Q2013 July 31-Jul-13 4,500 1.91 3.89
20-year New Issue of GII (Mat on 08/33) 20 3Q2013 August 30-Aug-13 2,500 1.63 4.58
5-year Re-opening of MGS (Mat on 03/18) 5 3Q2013 September 13-Sep-13 3,500 1.57 3.53
7.5-year New Issue of GII (Mat on 03/21) 7 3Q2013 September 23-Sep-13 3,500 1.75 3.72
30-year New Issue of MGS (Mat on 09/43) 30 3Q2013 September 30-Sep-13 2,500 2.44 4.94
10-year Re-opening of MGS (Mat on 03/23) 10 4Q2013 October 14-Oct-13 3,000 1.55 3.80
5.5-year New Issue of GII Mat on 04/19) 5 4Q2013 October 30-Oct-13 3,000 1.82 3.56
15-year Re-opening of MGS (Mat on 06/28) 15 4Q2013 November 15-Nov-13 2,000 1.55 4.27
10.5-year New Issue of GII (Mat on 05/24) 10 4Q2013 November 22-Nov-13 4,000 1.68 4.44
7-year Re-opening of MGS (Mat on 07/20) 7 4Q2013 November 29-Nov-13 3,000 1.77 4.03
15-year New Issue of GII (Mat on 12/28) 15 4Q2013 December 06-Dec-13 2,000 2.87 4.94
3-year Re-opening of MGS (Mat on 07/16) 3 4Q2013 December 13-Dec-13 3,500 1.57 3.29
IssuesTenure
(Years)
Target
QuarterTarget Month
Issue
Date
Amount
(RM Mil)
Bid-To-Cover ratio
(x)Average Yield (%)
10-year New Issue of SPK (Mat on 03/23) 10 1Q2013 March 22-Mar-13 1,700 1.84 3.73
7-year New Issue of SPK (Mat on 08/20) 7 3Q2013 August 19-Aug-13 2,700 1.53 3.97
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 13
Exhibit 16: MGS / GII and SPK auction calendar for 2014
Source: FAST, MARC Fixed Income Research
IssuesTenure
(Years)
Target
Quarter
Target
Month
10.5-year New Issue of MGS (Mat on 07/24) 10 1Q2014 January
5-year Re-opening of GII 04/19 3.558% 5 1Q2014 January
15-year Re-opening of MGS 04/30 4.498% 15 1Q2014 February
7-year Re-opening of GII 03/21 3.716% 7 1Q2014 February
3-year New Issue of MGS (Mat on 03/17) 3 1Q2014 March
10-year Re-opening of GII 05/24 4.444% 10 1Q2014 March
7.5-year New Issue of MGS (Mat on 09/21) 7 1Q2014 March
15-year Re-opening of GII 12/28 4.943% 15 2Q2014 April
5.5-year New Issue of MGS (mat on 10/19) 5 2Q2014 April
20-year Re-opening of MGS 04/33 3.844% 20 2Q2014 May
3.5-year New Issue of GII (Mat on 11/17) 3 2Q2014 May
10-year Re-opening of MGS (Mat on 07/24) 10 2Q2014 May
7-year Re-opening of GII 03/21 3.716% 7 2Q2014 June
3-year Re-opening of MGS (Mat on 03/17) 3 2Q2014 June
20-year Re-opening of GII 08/33 4.582% 20 2Q2014 June
5-year Re-opening of MGS (Mat on 10/19) 5 3Q2014 July
15-year Re-opening of GII 12/28 4.943% 15 3Q2014 July
7-year Re-opening of MGS (mat on 09/21) 7 3Q2014 August
10-year Re-opening of GII 05/24 4.444% 10 3Q2014 August
3-year Re-opening of MGS (Mat on 03/17) 3 3Q2014 September
30-year Re-opening of MGS 09/43 4.935% 30 3Q2014 September
5-year Re-opening of GII 04/19 3.558% 5 3Q2014 September
15-year Re-opening of MGS 04/30 4.498% 15 4Q2014 October
3-year Re-opening of GII (Mat on 11/17) 3 4Q2014 October
10-year Re-opening of MGS (Mat on 07/24) 10 4Q2014 November
5-year Re-opening of MGS (Mat on 10/19) 5 4Q2014 November
10-year Re-opening of GII 05/24 4.444% 10 4Q2014 December
7-year Re-opening of MGS (Mat on 09/21) 7 4Q2014 December
IssuesTenure
(Years)
Target
Quarter
Target
Month
10-year new Issue of SPK (Mat on 02/24) 10 1Q2014 February
7.5-year New Issue of SPK (Mat on 10/21) 7 2Q2014 April
10-year Re-opening of SPK (Mat on 02/24) 10 3Q2014 August
7-year Re-opening of SPK (Mat on 10/21) 7 4Q2014 October
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 14
Foreign holdings of MGS
dropped following Fed’s
tapering plan talks in May
2013
But some capital flowed back
after the Fed surprised the
market
Ringgit weakened by as
much as 8.3% following the
outflows of capital
Exhibit 17: MGS and GII bonds issuance trends
Source: BPAM, FAST, MARC Fixed Income Research
Macroeconomic factors influencing local bond market
Negative Factors
Impact of the planned tapering by the Fed
Following Chairman Ben Bernanke‟s tapering talks in mid-May, foreign holdings of MGS
dropped for four consecutive months from May to August 2013, the longest stretch since
April 2009. In addition, Fitch Ratings‟ revision of Malaysia‟s sovereign credit outlook to
„negative‟ from „stable‟ in July fueled outflows of foreign capital from the country,
triggering a sell-off in the equity and bond markets, a depreciation of the ringgit against
the USD, and rising bonds yields. As of end-September, foreign investor holdings
dropped to RM128.12 billion, equivalent to 42.8% of total outstanding MGS compared to
the peak of RM144.98 billion in April this year. As of October, foreign investors sold
about RM6.6 billion worth of MGS compared to the highest holdings back in April.
However, some foreign funds were back into the local market after the US Fed surprised
the market by deciding to maintain its monthly bond purchases programme at USD85
billion during the FOMC meeting in late October, leading investors to believe that the
central bank will delay its tapering plan until the 1Q2014. By December however, the
Fed finally announced its tapering plan to cut back USD10 billion from its monthly
purchases starting January 2014.
With the relatively high foreign holdings of MGS, the ringgit was sensitive to the US
Fed‟s tapering plan even before the actual cutback was announced in mid-December.
The ringgit weakened by as much as 8.3% to RM3.33 in August, the weakest level since
mid-2010 as foreign investors trimmed their holdings of MGS. Despite recovering some
of its losses in the following months after the Fed unexpectedly refrained from winding
down its stimulus policy, the local currency still posted a loss of 7.1% year-on-year in
2013, the worst annual drop since the Asian Financial Crisis.
43.5
60.0
37.1
57.354.2
51.5
16.5
28.5
21.0
36.0
42.0 41.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
2008 2009 2010 2011 2012 2013
MGS GIIMYR bil
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 15
CDS also reacted to Fed’s
tapering plan, climbing to
158 bps
But retreated to below +1.0%
of its SD by September
Ballooning household debt is
a concern especially if
interest rates were to rise
Exhibit 18: Ringgit vs. foreign holdings of outstanding MGS
Source: BNM, CEIC, MARC Fixed Income Research
In the CDS market, the price of Malaysia‟s five-year CDS, which was trading below 1.0 standard deviation before Bernanke hinted at tapering in May, hit its highest level for the year at 158 bps as investors rushed for safe haven instruments following US Secretary of State John Kerry‟s comments that there was firm evidence of the Syrian government using chemical weapons against its own people, triggering worries over the possibility that the US government will lead a military strike against Syria. Nonetheless, waning concerns of a possible US-led strike coupled with the unexpected decision by the Fed to delay its tapering plan after its September FOMC meeting brought the CDS price sharply lower to slightly below its +1.0 standard deviation level. Exhibit 19: Malaysia’s CDS market responded to the Fed’s tapering news
Source: Bloomberg, MARC Fixed Income Research
Household debt and narrowing current account surplus are the
primary concerns
Ballooning household debt is an area of concern which could amplify the country‟s credit
risk. Malaysia‟s household debt-to-GDP ratio reached a record high of 82.9% in the
3Q2013, among the highest among Asian countries. Thus far, the risk of Malaysia‟s
household debt has been mitigated by high household financial assets and low interest
rates. Nonetheless, things may change after the Fed starts to scale back its asset
purchases and the domestic economy reacts to higher inflation in 2014. The concern is
that emerging markets – Malaysia included – may have to raise their benchmark interest
rates which make the sustainability of high debt questionable. This is negative for the
bond market.
2.8
2.9
3.0
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.85.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0
55.0
Foreign Holdings of Outstanding MGS (%, LHS)
MYR/USD (RHS)% MYR/USD
60
80
100
120
140
160
180
Malaysia 5Y CDS
+1 SD
-1 SD
Mean
bps
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 16
Declining CA surplus and
lingering budget deficits are
also ‘credit negative’ for
Malaysia
Sovereign yield spreads
have narrowed making it less
appealing for MGS
Exhibit 20: Ballooning household debt amplify the country’s credit risk
Source: BNM, CEIC, MARC Fixed Income Research
In addition, a narrowing current account surplus and a decade-long budget deficit are
among other concerns raised by Fitch Ratings. Despite a seri¬es of fiscal-tackling
measures that were announced during the tabling of Malaysia‟s Budget 2014, including
the timeframe for the implementation of the GST and the resumption of the subsidy
rationalisation plan, Fitch maintained the country‟s „negative‟ outlook stating that policy
implementation “remains key to limiting further credit pressure on the sovereign rating”.
Narrowing of sovereign spreads
Given the rising yields in the major developed countries, sovereign yield spreads of
MGS against their sovereign bonds are narrowing, tempering investor appetite for MGS
as they shift their interest to major sovereign bonds which are now offering rising yields.
Compared to the widest sovereign spread of 173 bps between the benchmark 10-year
MGS and UST yields in early April 2013, the spread has narrowed by 62 bps to 111 bps
on 24 December. Similarly, sovereign yield spreads between MGS and UK Gilts
continued to tighten, increasing the risks of further foreign capital outflows from
Malaysia. A similar trend was observed regionally where yields of several countries‟
sovereign bonds climbed faster than the MGS, making the latter less attractive
compared to regional peers‟ local govvies.
Exhibit 21: Narrowing sovereign spread has dampened demand for MGS
Source: Bloomberg, MARC Fixed Income Research
55.0
60.0
65.0
70.0
75.0
80.0
85.0 Household debt-to-GDP (%)%
-600
-550
-500
-450
-400
-350
-300
-250
-200
-150
-100
0
50
100
150
200
250
MGS/UST (bps, LHS) MGS/Gilt (bps, LHS)
MGS/Indonesia (bps, RHS) MGS/India (bps, RHS)
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 17
Slower economic growth
momentum in China is also
negative for Malaysia
A slowdown in regional
economies – India,
Indonesia and Thailand – if it
prolongs, will also be
negative for Malaysia
On the positive side, real
interest rates will likely
remain positive as we expect
an increase in the OPR in
2014
Slowing regional economic growth
Apart from the anxiety over the Fed‟s tapering plan, another potential risk stems from
slower economic growth in regional countries, particularly in the Chinese economy
where medium-term growth prospects are clouded by changes in economic
fundamentals, risking the economy from sustaining its strong growth trajectory despite
the better-than-expected expansion in the 3Q2013. As the world‟s second-largest
economy and one of Malaysia‟s largest export markets, a persistent slowdown in
China‟s economic growth will exert more pressure to the Malaysian financial market and
make MGS less attractive against regional sovereign bonds.
A slowdown in India‟s economy is also another concern as the country is an important
trading partner for many Asian nations. India‟s growth momentum is under pressure due
to rising interest rates caused by high inflationary pressure. Indonesia‟s economy is also
moderating with growth slipping to below 6% in the 3Q2013, while in Singapore,
continuous pressure to address the problem of high property prices has caused the
property sector to be hit in the 3Q2013. In Thailand, ongoing political turmoil arising from
efforts to depose the present Prime Minister is weakening the domestic economy,
causing the government to downgrade its growth forecast for 2014 to between 4% and
5%. Such negative sentiments in the regional economies, should they prolong, will not
augur well for the Malaysian economy. Notwithstanding, the ongoing improvement in the
US economy as well as some stabilisation in the euro zone are providing an important
boost to global economic conditions which would prevent investors from completely
fleeing the MGS market.
Positive factors
Persistent positive real interest
In response to capital outflows, inflation and weakening currencies, some Asian central
banks have raised their benchmark interest rates in recent months. For instance, Bank
Indonesia pushed up its benchmark interest rate by five times in 2013 with cumulative
increases of 175 bps since early June to 7.50%. Similarly, the Reserve Bank of India
revised upward its benchmark repurchase rate (repo rate) for two consecutive months in
October and November by 25 bps each to 7.75% from 7.25% in September. As for
Malaysia, although BNM has maintained the OPR at 3.0% throughout 2013, we believe
that the rising inflation rate in 2014 coupled with additional capital outflows in the wake
of the Fed‟s tapering actions will induce BNM to raise the policy rate by 25 bps, keeping
the real interest rate positive.
Exhibit 22: Real interest rate: Malaysia vs. selected countries
Source: Bloomberg, MARC Fixed Income Research
-3-2-2-1-10112Malaysia
US
UK
EuroThailand
India
Indonesia
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 18
Real yields for MGS are also
higher than some sovereign
bonds
Malaysian government
external debt remains low
and high level of
international reserves will
provide sufficient buffer
should there be outflows
In addition, investment returns based on real yields still favour MGS when compared to
major sovereign bonds and selected regional bonds due to Malaysia‟s relatively low
inflation environment. In our view, such a scenario will limit the outflows going forward.
For example, after adjusting for inflation, the benchmark 10-year real yield for MGS
(1.19%) is higher than that for UK Gilts (0.88%), German Bunds (0.59%) and JGBs (-
0.82%).
Exhibit 23: Persistent positive real interest rate offered by Malaysia
Source: Bloomberg, MARC Fixed Income Research
Exhibit 24: 10-year real yield: MGS vs. major sovereign bonds
Source: Bloomberg, MARC Fixed Income Research
Minuscule federal government external debt
Despite a relatively high total government debt-to-GDP ratio, the federal government‟s
external debt remains minuscule, accounting for only 3.2% of total government debt in
the 3Q2013. In addition, the government‟s external debt-service ratio continued to
decline to 0.1%. Meanwhile, BNM‟s international reserves increased to RM440.8 billion
or USD135.3 billion as of mid-December 2013 from RM331.3 billion in 2009, sufficient to
finance 9.4 months of retained imports and are 3.7 times of the short-term external debt.
The relatively high level of international reserves will provide a sufficient buffer should
there be a rapid withdrawal of foreign capital from the country. At the same time, the
long-term trend of the government‟s external debt remains favourable as it has been
declining since June 2003 before hovering around RM16 billion to RM18 billion in the
past two years.
Period Malaysia US UK Euro Thailand India Indonesia
Mar 11 -0.25 -2.45 -3.50 -1.70 -0.64 -2.93 0.10
June 11 -0.50 -3.35 -3.70 -1.45 -1.06 -2.01 1.21
Sept 11 -0.40 -3.65 -4.70 -1.50 -0.52 -1.75 2.14
Dec 11 0.00 -2.75 -3.70 -1.70 -0.28 0.76 2.21
Mar 12 0.90 -2.45 -3.00 -1.70 -0.45 0.81 1.78
June 12 1.40 -1.45 -1.90 -1.40 0.44 0.42 1.22
Sept 12 1.70 -1.75 -1.70 -1.85 -0.38 -0.07 1.44
Dec 12 1.80 -1.45 -2.20 -1.45 -0.88 0.69 1.45
Mar 13 1.40 -1.25 -2.30 -0.95 0.06 1.85 -0.15
June 13 1.20 -1.55 -2.40 -1.10 0.25 2.09 0.10
Sept 13 0.40 -0.95 -2.20 -0.60 1.08 0.45 -1.15
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0UST
MGS
GiltBund
JGB
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 19
We do not anticipate
massive outflows due to the
stable demand for local
govvies from international
institutional investors
…as well as demand from
domestic institutional
investors
We maintain an upside bias
of MGS yields and expect
the yield curve to steepen
However, the MGS will likely
be sufficiently supported by
demand from institutional
investors
Exhibit 25: Declining government external debt is favourable to investment
Source: CEIC, MARC Fixed Income Research
Sufficient support from domestic investors
We continue to believe that foreign investors will not totally abandon local govvies as
long-term investors such as sovereign wealth funds, insurance companies and other
institutional investors are less influenced by changes in the US Fed‟s monetary policy
but tend to focus more on Malaysia‟s long-term economic fundamentals. Indeed, we see
the current level of capital outflow as a healthy phenomenon given that the massive
global liquidity in the past few years has driven up Malaysia‟s asset prices and
household debt significantly.
Furthermore, the Malaysian bond market has consistently been supported by large
domestic institutional investors such as KWAP, the EPF and insurance companies. This
is evidenced by the growing investible fund size of institutions such as the EPF, KWAP,
unit trusts, insurance and Takaful companies. Strong demand from domestic investors
was also seen during the debut of BNM‟s inaugural 30-year MGS note – a highly sought
after instrument by long-term investors – which was oversubscribed by 2.44x despite it
being offered at a time when foreign capital was flowing out from the country.
Given these reasons, we continue to opine that domestic institutional investors will lend
support to the local govvies market, mitigating some of the impact from a reversal of
global capital flows back to developed economies after the Fed scales back its asset
purchases programme.
Our View : Maintain Upside Bias on MGS Yield Curve We maintain our view of an upside bias for MGS yields and expect the yield curve to
steepen further from the current level in the wake of an improving US economy and
labour market which would warrant the US Fed to continue its tapering plan at a
measured pace in 2014. Secondly, a slow but steady recovery of other advanced
economies including the euro zone and Japan would lead to further expectations of
capital outflows from this region – Malaysia included - despite providing a reasonable
support to Malaysia‟s headline GDP growth. Thirdly, on the local front, stronger CPI
growth especially in the 2H2014 on the back of the resumption of the subsidy
rationalisation plan and the rollout of the GST planned for April 2015 will further exert
upward pressures on bond yields. Our economics team believes that BNM will raise the
benchmark OPR by 25 bps in order to be ahead of the curve in dealing with higher
consumer prices and possible capital outflows in 2014. Notwithstanding rising yields, we
are of the view that MGS will be sufficiently supported by demand from institutional
investors.
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0 Govt External Debt-to-Total Govt Debt (%)%
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 20
Primary market activities
were quieter in 2013 when
compared to the bumper
year of 2012
Exhibit 26: Malaysia’s real GDP, CPI and OPR
Source: CEIC, MARC Fixed Income Research
The Ringgit Corporate Bond
Corporate bond issuance Primary market activities for the year 2013 were relatively quiet compared to the bumper
year of 2012 even after excluding the RM30.6 billion issued by PLUS Bhd in 2012
(RM19.6 billion and RM11.0 billion for the AAA-rated and GG-unrated segments
respectively). For the year 2013, gross corporate bond issuances fell by 30% to RM86.2
billion compared to RM123.8 billion issued in the preceding year. On a year-on-year
basis, lower bond issuances were mainly dragged down by smaller issuances from the
unrated quasi-government sector and rated corporate bonds which fell by RM16.9 billion
and RM24.2 billion respectively although Cagamas increased its issuance by RM4.5
billion.
Exhibit 27: Corporate bond issuance trends
Source: BPAM, MARC Fixed Income Research
For the year 2013, the utilities sector dominated primary market activities with a total
RM27.7 billion raised. The AA-rated Malakoff Power issuance alone amounted to
RM10.98 billion, followed by the Cagamas issuance of RM7.9 billion. Activities in the
primary market continued to be dominated by investment grade bonds while it remained
inaccessible for those rated BBB and below, implying that high-risk borrowers will
continue to face difficulty in raising capital in this market.
1.0
1.5
2.0
2.5
3.0
3.5
4.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0Real GDP (% y-o-y, LHS) CPI (% y-o-y, LHS)
OPR (%, RHS)
% %
20.0
40.0
60.0
80.0
100.0
120.0
140.0
2008 2009 2010 2011 2012 2013
Rated Corporate Bonds Unrated Corporate Bonds
Unrated GG Cagamas
RM bil
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 21
Islamic PDS issuances will
likely increase more in
response to government’s
initiative to promote Islamic
capital market
Profitability of companies
has moderated but broad-
based credit deterioration is
not likely
Any negative rating will likely
be issuer or sector- related
Exhibit 28: 2013 Corporate bond issuance : Industry and rating distribution
Source: BPAM, MARC Fixed Income Research
With the government‟s efforts to promote the Islamic capital market, it is not surprising to
see Islamic PDS issuances increased during the year. Going forward, we are of the view
that the Securities Commission‟s stricter Shariah-compliant rules which took effect from
29 November 2013 would induce some companies to convert their conventional debt to
Islamic debt, raising the Islamic-to-conventional debt ratio.
Given the government‟s elevated debt level and rapid increases in contingent liabilities,
we foresee less leeway for the government to guarantee future debt. Furthermore,
expectations of a moderation in the overall domestic economy as well as uncertainties
over the speed of the US Fed tapering of bond purchases will likely cause gross
corporate bond issuance to moderate slightly in 2014 to between RM65 billion and
RM75 billion.
Lower profit margin but no worrying signs Judging by the weighted average profit margin of constituents in the FTSE Emas Index,
the profitability of Malaysian companies has slightly moderated to 13.3% as of 27
December compared to 13.8% in 2012. In addition, the leverage levels of companies
under coverage have increased, evidenced by their increasing total debt-to-total assets
ratio to 19.1% as of 27 December 2013 (2012: 18.2%). We are of the view the lower
profit margin is mainly due to uncertainties in the external environment and slowdown in
regional economic growth. Nonetheless, we think that corporate earnings have generally
remained stable and that there are no serious concerns on the overall credit quality. We
do not see broad-based credit deterioration in 2014 due to respectable headline
economic growth of circa 5%, supported by the relatively strong private investment and
resilient private consumption growth, albeit slower than in 2013. Our view is that any
negative rating will mainly be issuer or sector-related.
0.1
0.2
0.4
1.8
2.3
2.3
3.2
11.1
13.9
32.2
32.5
Mining & Petroleum
Industrial Products
Consumer Product
Trading & Services
ABS
Transportation
Plantation
Property & …
Conglomerate
Utilities
Financial
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0
%
AAA29.2
AA69.0
A1.8
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 22
We anticipate the
downgrade-to-upgrade ratio
to remain above one in 2014
Number of defaults rose in
2013 but concentrated in
industrial product sector
Exhibit 29: FBMEmas Index : Financial analysis
Source: Bloomberg, MARC Fixed Income Research
In 2013, the downgrade-to-upgrade ratio based on the issue count in MARC‟s universe
rose to 8.0x (Upgrade: 1; Downgrade: 8) compared to 7.3x in the previous year. At this
juncture, we continue to expect to see the downgrade-to-upgrade ratio to stay above
one in 2014 with the industrial product sector continuing to dominate negative rating
actions. The steel sector, a sub-component of the industrial product sector, will continue
to face depleting margins amidst overcapacity of steel production in China coupled with
softening steel prices. In addition, although we do not anticipate a significant downgrade
risk from the property sector, a slew of cooling measures announced by the government
and BNM to rein in rising house prices could exert downward pressure on property
companies‟ profitability, dampening the sector‟s outlook.
Meanwhile, the number of defaults fell to 2 issues from the previous year‟s 7 issues.
Again, default cases were mostly concentrated in the industrial product sector, led by
Kinsteel Bhd and Perwaja Steel Sdn Bhd. MARC has downgraded Kinsteel Bhd‟s
RM100 million Murabahah Commercial Papers/Medium Term Notes Programme to DID
from MARC-4ID / CID following the company‟s failure to redeem its outstanding RM40
million Murabahah CP on 5 September 2013. Meanwhile, Perwaja‟s RM400 million
Murabahah MTN programme was downgraded to DID from CID after the company‟s
failure to meet repayment of its RM50 million MTN due on 25 September 2013.
Exhibit 30: Rating migration in MARC universe by issue count
Source: MARC Fixed Income Research
2013 (YTD*) 2012 Changes
FBMEmas Index 12815.8 11438.1 1377.7
Sales per Share (MYR) 5714.0 5876.4 (162.37)
Profit Margin (%) 13.3 13.8 (0.57)
Operating Margin (%) 16.6 17.5 (0.87)
Return-on-Asset (%) 2.6 2.8 (0.18)
Total Debt-to- Total Equity (%) 81.7 81.7 (0.05)
Total Debt-to-Total Assets (%) 19.1 18.2 0.9
* as of 27 December 2013
6
12
3 31
26
3032
22
8
12
8
3
7
2
0
5
10
15
20
25
30
35
40
2009 2010 2011 2012 2013
Upgrade Downgrade Default
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 23
We maintain an upside bias
for corporate bond yields on
the back of a steepening
government bond yield curve
Investment grade bonds will
likely dominate local bond
origination
Exhibit 31: Rating migration by sector in MARC universe for 2013
Source: MARC Fixed Income Research
PDS Outlook As with the trend in the sovereign bond market, we maintain an upside bias for
corporate bond yields on the back of a steepening government bond yield curve.
Nonetheless, we expect the magnitude of increases in corporate bond yields to be
smaller than those of MGS, thus narrowing the corporate yield spread as corporate
bonds are less sensitive to external shocks amid low foreign holdings. At the same time,
the corporate bond market is not expected to be as volatile as the local govvies market
and shrinking transaction volumes are expected as investors continue to stay on the
sidelines in response to uncertainties over the speed of the tapering by the US Fed, and
the global economic landscape.
In the primary market, investment grade bonds will likely continue to dominate the local
bond origination market while the market will remain lackluster for those rated BBB and
below. Looking at the Exhibit 31, we attribute the relatively wide yields spread of this
rating segment compared to higher rated bonds as a main deterrent to issuers rated A
and below from entering the primary market.
Exhibit 32: Wide yield spreads for A-rated and below is the main reason that deterring these borrowers from local bonds market
Source: Bloomberg, BPAM, MARC Fixed Income Research
Issue
Count
Issue Size
(RM mil)
Issue
Count
Issue Size
(RM mil)
Issue
Count
Issue Size
(RM mil)
Industrial Products 3 724 2 500
Infrastructure & Utilities 4 6,180
Consumer Products 1 300
Technology 1 10
Total 1 10 8 7,204 2 500
Sector
Upgrade Downgrade Default
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0%
5Y MGS 5Y AAA 5Y AA1
5Y A1 5Y BBB1
2014 Bond Market Outlook
MARC Fixed Income Research www.marc.com.my 24
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