Fixed Income Quarterly Report - 2Q15

Please find our latest 2Q2015 Fixed Income outlook. The following is key points for your kind reading :-

v We have seen another leg of fierce bond rally at the start of the year with an action-packed of central banks easing in reaction to European Central Bank’s (ECB) own version of quantitative easing (QE). To intensify the drama, Switzerland became the first country to auction off 10-year bonds with a negative yield, as the country is fighting the risk of deflation and threaten to make already negative interest rate even more negative resulting in a sharp flattening of long-dated forwards in G-10 economies.

v With falling Asian inflation by roughly one-third over the past six months, this drove broad rally in bond markets along with global low rates, flush liquidity conditions and supply-demand dynamics even though currency weakness took some sheen out of total returns especially in markets that have low yielding bonds without any carry buffer.

v Malaysian govvies (MGS) rallied in shorter tenures due to pricing-in for easier monetary policy, continued decline in KLIBOR rate and inclusion of Malaysia into Barclays Global Aggregate Index, which resulting a steeper yield curve. Bank Negara Malaysia (BNM) however didn’t join into the easing club and kept its Overnight Policy Rate (OPR) steady at 3.25%.

v Into 2Q2015, we argue that yield hunting will be game of the day. Long end inflation break-evens have bottomed out since mid-January given the easy monetary policy, stable global growth and improving inflation news will provide necessary support in rising inflation expectations.

v Bonds look overvalued US economy will likely to regain momentum in the spring with marked shift in optimism over ECB QE from a quarter ago and Bank of Japan is betting on wage pressure and exports to defend its bullish view that the economy is entering a virtuous cycle of recovery. We expect foreign inflows to local-currency bonds to remain supportive, particularly in high-yielding markets of which inflows are supported by favourable global liquidity and by the increased GBI-EM-GD index weightings and the recent inclusion of Malaysia into Barclays Global Aggregate Index. The likelihood of investors to extend duration risk will likely to rise even as they may reduce notional risk.

v In the case of Malaysia, risk of massive capital outflows due to high foreign ownership of MGS is reduced. Real interest rate has been on the rising trend since second half of 2014 from 0.65% in 3Q2014 to recent high of 3.15% in February 2015. We think the central bank would be loath to cut policy rate given still elevated household debt, risk of further decline in foreign exchange reserve and the inflationary impact of GST in April 2015.

v We continue to be a strong advocate of yield investing into private debt securities (PDS) space as credit spread conditions of PDS showing sign of encouragement. The 10-year MGS yield against equivalent AAA and AA1 spread is about 81-140 basis points against sub-60 basis points in mid-2013.