BACK in Q2 2021, as yields started to recover 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 Malaysian bond funds generated positive returns during the quarter, with an average absolute return of 1.5%, which equates to 6% on an annualized basis.
On the other hand, Malaysian short bond funds returned 0.68 percent on average, while Malaysian money market funds returned 0.43 percent on average over the same period.
As we enter the second half of the year, we believe there is a high probability that Malaysian medium to long duration bonds will continue to outperform short bonds and the money market in the future.
Therefore, Malaysian fixed income investors should continue to invest with a medium to long duration positioning and seek opportunities in lower rated / unrated credits for the following reasons:
1. Prolonged confinement put the brakes on the national economic recovery
Despite the implementation of a full nationwide lockdown (FMCO) since early June, the number of Covid-19 cases has not declined, leading the government to extend the lockdown and impose even stricter measures on specific areas (EMCO).
With the exception of some essential industries, most companies have been ordered to cease operations, causing economic activity to come to a complete halt. The sharp drop in the Purchasing Managers’ Index (PMI) to 39.9 in June 2021 came as no surprise as companies have become cautious.
A PMI below 50 indicates a contraction in economic activity. Exports are also expected to take a hard hit amid disrupted manufacturing activity.
After improving slightly to 4.6% in April 2021, the unemployment rate is expected to rise as companies implement job cuts to deal with the lockdowns.
The weakening of the labor market would inflict further damage on private consumption.
Although retail sales surged in April 2021, consumer spending is expected to slow from May due to mobility restrictions until we see some easing of the lockdown.
Subsequently, these latest developments undermined the national economic recovery. As such, we have lowered Malaysia’s GDP growth forecast for 2021 to 5.1% yoy, from the 5.7% yoy originally forecast in May.
2. BNM considers the peak of inflation to be transitory
The spike in inflation in March, April and May 2021 – the highest rate since 2018 – could suggest inflationary pressures have crept into the country.
That being said, we believe they are most likely temporary due to the weak base effect caused by price deflation a year ago and cost inflation due to the recent surge in commodity prices such as as petroleum, steel, copper and palm oil to name a few.
We should see inflation numbers decline over the next few months after the weak base effect wears off amid weak consumer demand in the country.
As such, we believe the BNM will view the spike in inflation as transient and reduce the urgency to raise rates in the short to medium term.
3. BNM will maintain the OPR for the foreseeable future.
Given the economic downturn and weakening consumer sentiment, we expect BNM to keep the OPR rate at the current rate of 1.75% at the next MPC meeting.
On the other hand, we believe that at this point there is no need to cut rates further because the marginal benefit of another rate cut has diminished.
Beyond that, we expect the BNM to maintain its accommodative stance for the foreseeable future, at least until the third quarter of 2022, in order to foster the post-pandemic economic recovery.
Conclusion: Fixed income investors should continue to invest with a medium to long term positioning and look for opportunities in lower rated / unrated credit
At present, we continue to advocate Malaysian medium to long term bonds, which we believe will continue to do well over the next 1.5 years.
On the one hand, investors can take advantage of pre-pandemic-level yields and spreads that are quite decent, while on the other hand, they only take a slightly higher duration risk which we believe is is also rather limited as most of the aggression has been built into the current returns. already.
That said, we still see attractiveness in the lower quality segment rated A or lower, as the upside and the spread is still very large, compared to bonds rated AAA or AA.
In fact, that rise and spread can help cushion the portfolio in the face of any interest rate volatility, like what happened in February and March of this year.