For the eighth consecutive month, the local bond market continued to see net positive foreign inflows in December. This was despite the Fitch downgrade of Malaysia's sovereign credit rating against the pandemic backdrop, and a strong indication that investors were buying into November's dip.

With net foreign inflows coming in at RM3.6 billion (November: RM2.5 billion), total foreign holdings rose to RM223.0 billion, the highest since November 2016. This took the total foreign share of outstanding local bonds to 13.9% (November: 13.6%).

Malaysian Government Securities (MGS) and Government Investment Issues (GII) were the primary drivers of December's net foreign inflows. Foreign holdings of MGS rose by RM2.4 billion to RM177.3 billion, which is equivalent to 41.1% of total outstanding MGS. Meanwhile, foreign holdings of GII increased by RM1.4 billion to RM24.8 billion, representing 6.6% of total outstanding GII.

Foreign demand for MGS in December was mainly driven by yield-hunting activities given that Malaysia had remained in deflationary territory and the US Federal Reserve's pledge to keep rates near zero at least through 2023. Demand for MGS was also supported by the broad weakness of the US dollar against the backdrop of improving global risk sentiment, which was boosted by the fresh USD900 billion US fiscal stimulus, the approval of the post-Brexit deal, early vaccine rollouts in both the US and the UK, as well as soaring crude oil prices.

Amid steady foreign demand, MGS yields ended December lower across the curve in a bull-flattening move. Yields along the 7y20y curve were largely lower by 9bps to 32bps while yields at the short end were lower by 3bps to 8bps. It is notable though that yields were still broadly higher compared to October. The 3y MGS settled 3bps lower at 1.88% after surging by 15bps in November. In the same period, the 10y MGS settled 9bps lower at 2.65% after rising by 12bps in the previous month.

For full year 2020, the local bond market accumulated RM18.3 billion of net foreign inflows. Foreign investors had been adding local bonds to their portfolios since May, thanks to attractive real yield valuations. The total net foreign inflows were led by MGS (+RM13.4 billion), followed by Malaysian Treasury Bills (+RM3.8 billion) and GII (+RM3.7 billion).

Moving into 2021, the recent implementation of another Movement Control Order, MCO 2.0 as well as the declaration of a state of emergency will affect sentiment, though a lot will also depend on how developments pan out further down the road. MGS yields had spiked in a knee-jerk reaction to the emergency declaration but have since been trending downwards.

Bank Negara Malaysia (BNM) left the OPR unchanged at 1.75% at conclusion of its January Monetary Policy Committee meeting. BNM viewed the current OPR level as appropriate and accommodative. Given this and the heavier supply of MGS/GII expected this year to support the government's fiscal initiatives, we expect the MGS yield curve to steepen further during 1H2021 with the 10y yield hovering between 2.60% and 2.80%. We expect gross issuance of MGS/GII in 2021 to come in at between RM150.0 billion and RM160.0 billion.

Contacts:
Tan Jack Fong, +603-2717 2958/ jackfong@marc.com.my;
Quah Boon Huat, +603-2717 2931/ boonhuat@marc.com.my;
Firdaos Rosli, +603-2717 2936/ firdaos@marc.com.my.