MY Fixed Income Outlook 2H15

MY Fixed Income Outlook 2H15

·         Knee-jerk optimism of Fitch raising Malaysia's outlook from negative to stable while reaffirming the A- rating should keep the MGS market supported. In the immediate term the 10y MGS yield may drift in a range of 3.90-3.95%, but may make a turn northward to the 4% handle if the US nonfarm payrolls surprise strongly on the positive side accompanied by the resumption of rising UST yields.

·         Supply profile to turn more favourable in 3Q15 with an estimated MYR8b net maturities of government bonds, but we don't expect the liquidity from net redemption to benefit the whole MGS curve as most of the rollover demand may favour the front-end sector, in our view. We maintain that gross MGS & GII supply to total MYR92b in 2015, or MYR102b including SPK.

·         On foreign holdings, we are actually mildly bearish, taking a view that the foreign holdings of MGS may edge downward to 45% from the existing 46.7%. We continue to think that MGS has benefited from the redirected flows from matured BNM notes, and this could be the source of volatility in 2H15. We think the appeal of domestic bonds to foreign investors should be little changed. Although Fitch's outlook increase may appear to be a "shot in the arm" on sentiment, this doesn't materially alter Malaysia's fundamentals. In fact the stable outlook by Fitch serves more like a reconciliation of view closer to those held by S&P and Moody's.

·         MGS curve outlook: we were tactically neutral in mid-June when the 10y MGS yield was around 4.10% on the basis of improved risk-reward, and recommended bidding in the 7y MGS auction because it was a cheap point due to supply indigestion. While the outlook increase by Fitch is now an added positive, we are somewhat discouraged by the existing levels after the sharp rally especially along the 7y10y sector (approx. 20-23bps stronger). Also, we remain wary that UST yields can re-price upward further as we draw closer to the start of the US interest rate normalisation as the current market implied pricing is still rich relative to the Fed dots. Therefore, we continue to recommend selling on rally and more inclined to express a mildly bearish view from current levels, with the 10y MGS yield averaging 4.00% in 3Q15, and target levels of 4.10% by end-3Q15, and 4.25% by end-4Q15.