Posted Date: March 18, 2021

The global bond rout deepened in February as the reflation trade continued to be a dominant theme. From the US to Germany and the UK, government bond yields ended the month with their biggest monthly surge in years. The sell-off first started in the US amid positive progress on Biden's USD1.9 trillion COVID-19 relief bill as well as a proposal for another stimulus worth USD2.0 trillion on infrastructure. Investors had anticipated that the spending plans would raise inflation growth rapidly, overheating the economy. This was exacerbated by the initiation of the global vaccination drive. Combined with the dovish hold of global central banks, yield curves steepened significantly.

In contrast, bond markets in China were pretty much shielded from the global sell-off as volatility from the cash crunch in January had reduced. China Government Bonds (CGB) recorded massive gains at the short end while yields at the long end barely rose. The CGB market was supported by record foreign inflows. While the US is embarking on a large-scale stimulus, China is sticking with its deleveraging campaign and market reforms, enticing yield hunters.

Malaysia was not spared as the aggressive yield pick-up seen in the US Treasuries (UST) market was also mirrored in the Malaysian Government Securities (MGS) market. Further selling pressure on MGS came from the local front. The Employees Provident Fund (EPF) had removed withdrawal conditions for the i-Sinar facility. With this, combined with i-Lestari withdrawals and the voluntary reduction in employees' 2021 share of statutory contribution rate to 9% from 11%, domestic investors believe that the EPF would continue to reduce their local government bond holdings.

Heavy supply of MGS/Government Investment Issues (GII) in February was also partly to blame. Gross issuance of MGS/GII amounted to RM12.0 billion, the same as the month before despite rising expectations of a speedier economic recovery in 2021. Furthermore, investors unwound their dovish bets as Malaysia's headline inflation growth slowly moved upwards into positive territory. January CPI slipped 0.2% y-o-y compared with a decline of 1.4% y-o-y in the previous month. Rising crude oil prices have stoked inflationary pressure in Malaysia.

Most of the selling pressure on MGS came from domestic investors as the local bond market continued to record foreign net inflows. Foreign investors continued to be net buyers of local bonds for the 10th consecutive month in February. The local bond market recorded total net foreign inflows of RM7.2 billion, bringing total foreign holdings to RM233.8 billion, which is the highest level since October 2016. The inflows were primarily driven by greater surges in foreign holdings of MGS and GII.

Foreign holdings of MGS amounted to RM183.1 billion (Jan: RM179.6 billion), equivalent to 41.2% of total outstanding MGS. The inflows into MGS were most probably concentrated along the 2y5y curve as positive yield differentials were little changed, negating some of the domestic selling pressure. Foreign demand was spurred by the relaxation of movement control orders and Malaysia's earlier-than-expected vaccination drive.

By end-February, the MGS yield curve shifted upwards on a steepening bias, with short-term yields rising by 1bp to 10bps while longer-term yields were up by 20bps to 50bps. The 10y/3y MGS spread widened to 114bps (Jan: 86bps), the highest since the 2009 Global Financial Crisis. Both the 3y and 10y MGS were last quoted at 1.94% (Jan: 1.84%) and 3.09% (Jan: 2.71%). Meanwhile, the monthly trade volume fell to RM42.0 billion (Jan: RM45.4 billion).

As of the time of writing, the 10y MGS yield was last quoted at 3.46%, which is near to 2020's all-time high of 3.59%. We foresee the yield curve steepening further with the 10y MGS yield moving between 3.50% and 3.70% amid: 1) the government's announcement of a fresh stimulus worth RM20.0 billion, and 2) the US Federal Reserve's (Fed) move to hold interest rates and the pace of bond purchases steady. The Malaysian government's newly proposed spending plans would heighten expectations of a heavier MGS/GII supply in 2021. Meanwhile, we expect the Fed's reiteration of its dovish stance despite sharply upgrading its 2021 forecasts to continue to fuelling reflation trades.

Tan Jack Fong, +603-2717 2958/ jackfong@marc.com.my;
Firdaos Rosli, +603-2717 2936/ firdaos@marc.com.my.