BACK in the second quarter of 2021, as yields started to pick up back to pre-pandemic levels, we recommended investors increase the duration of their Malaysian bond portfolios.
So far, investors who have followed the call would have done pretty well. All 20 Malaysia bond funds brought in positive returns during the quarter with an average absolute return of 1.5 per cent, which is equivalent to six per cent annualised.
On the other hand, Malaysia short duration bond funds returned 0.68 per cent on average whereas Malaysia money market funds returned 0.43 per cent on average over the same period.
Going into the second half of the year, we opine that there is a high likelihood that Malaysia medium to long duration bonds would continue to outperform short duration bonds and money market going forward.
Hence, Malaysia fixed income investors should continue to stay invested with medium to long duration positioning and seek opportunities in lower rated / unrated credit due to the following reasons:
1. Prolonged lockdown has put a dent in the domestic economic recovery
Despite the implementation of a nationwide full lockdown (FMCO) since the beginning of June, the number of Covid-19 cases has not abated, leading to the government extending the lockdown and imposing even stricter measures on specific areas (EMCO).
Apart from some essential industries, most businesses were ordered to stop operations, causing economic activity to come to a complete halt. The sharp drop in Purchasing Managers Index (PMI) to 39.9 in June 2021 came as no surprise as businesses turned cautious.
A PMI reading below 50 indicates contraction of economic activity. Exports are also expected to take a hit amid disrupted manufacturing activities.
After slightly improving to 4.6 per centin April 2021, the unemployment rate is expected to tick higher as businesses implement job cuts to weather through lockdowns.
The weaker labor market would inflict further damage on private consumption.
Although retail sales surged in April 2021, consumer spending is likely to soften from May onwards amid restrictions in mobility until we see some loosening of the lockdown.
Subsequently, these latest developments have put a dent in the domestic economic recovery. As such, we have downgraded Malaysia’s 2021 GDP growth forecast to 5.1 per cent year on year (y-o-y)compared to 5.7 per cent y-o-y initially forecasted in May.
2. BNM to look through inflation spike as transitory
The spike in inflation in March, April and May 2021 – the highest rate since 2018 – might suggest that inflationary pressure has crept up in the country.
That being said, we believe these are most likely temporary due to the low base effect caused by the deflation in prices one year ago and cost-push inflation due to the recent spike in commodity prices such as oil, steel, copper and palm oil to name a few.
We should see inflation numbers taper down in the upcoming months after the low base effect wears off amid soft consumer demand conditions in the country.
As such, we believe BNM will look through inflation spike as transitory, and reduce the urgency to raise rates in the short to medium run.
3. BNM to maintain OPR for the foreseeable future
Taking into account the slowdown in economic conditions and weaker consumer sentiment, we foresee BNM maintaining the OPR rate at the current rate of 1.75% during the upcoming MPC meeting.
On the other hand, we think that at this juncture, there is no need to reduce rates further as the marginal benefit of another rate cut has diminished.
Beyond that, we expect BNM to maintain their accommodative stance for the foreseeable future, at least until the third quarter of 2022, in order to aid the post-pandemic economic recovery.
Conclusion: Fixed income investors should continue to stay invested with medium to long duration positioning and seek opportunities in lower rated / unrated credit
At this current juncture, we continue to advocate medium to long duration Malaysia bonds, which we think will continue to do well over the next 1.5 years.
On one hand, investors can enjoy pre-pandemic level yields and spreads which are pretty decent, while on the other hand, only taking slightly higher duration risk which we also believe is rather limited as most of the hawkishness has been priced into the current yields already.
That said, we still see attractiveness in the lower grade segment A-rated segment or below, as the yield pickup and spread are still very substantial, compared to AAA or AA-rated bonds.
In fact, this yield pickup and spread can help to cushion the portfolio amid any interest rate volatility, as what had happened in February and March this year.