Malaysian bonds in for more volatility

PETALING JAYA - There could be more volatility ahead for local bonds in the face of the US Federal Reserve's move to gradually cut back on its bond-buying programme, commonly known as the tapering of quantitative easing (QE) measures.

Franklin Templeton Investments' Malaysia fixed income and sukuk head Hanifah Hashim said in a statement made available to StarBiz that financial markets would be seeking equilibrium in the wake of the QE tapering, thereby increasing volatility in the local fixed income market.

"Looking ahead, we are at a stage where risk-on-risk-off trend becomes a norm in the fixed income market as the world adjusts to the prospect that QE will not continue perpetually. Within this timeframe, the bond market will be dotted with volatility along the way as it finds a comfortable level through this adjustment period," she said.

However, analysts also said that on a global basis, fixed income and in particular Asian local currrency bonds would be more positive as they expect benchmark US interest rates to remain low to support economic growth.

Hanifah said that ringgit-denominated sukuk and corporate bonds would perform better in this volatile period, as there were ample domestic liquidity to support new issuances and short-term outflows (if any).

"For the portfolios that I manage, we are keeping the local currency fixed income duration short and looking at selected five-year corporate credits as it provides the best combination of yields with minimum duration risk in this market condition," she said.

Overall, Hanifah said the default rate for Malaysian corporate credit as well as sukuk remained very low, at about less than 5 per cent, as most of the issuers wre financially sound and in healthy shape.

"As such, we believe the good quality corporate credit is a good investment option in 2014 within the fixed income space," she said.

Hanifah said the high foreign holding of Malaysian government bonds, currently at above 40 per cent even after the adjustment in mid- 2013, indicated that foreign inflows were driven by easy-money policy in developed countries especially the United States, and this can reverse fairly quickly and impact the bond market.

"Bond yields however, have moved higher in 2013 and have already partially priced-in QE tapering risk.

"We believe should our domestic economic fundamentals perform well and surprise on the upside, this will help to mitigate the risk of bond yields from rising further in 2014, even with QE in store, as foreign investors will continue to invest in Malaysian bond market to seek higher return," she said.

On a broader perspective, Schroders Asian fixed income head Rajeev De Mello believes that global fixed income and Asian local currency bonds would be more positive.

"While the Fed may start its QE tapering process in the first quarter of 2014, it has indicated that it will keep the Fed funds rate low for a prolonged period of time, possibly until early 2016, as it seeks to boost US employment conditions.

"Against this backdrop, upward pressure on global bond yields may be lower during 2014 than what we witnessed between April and August this year," he said.

De Mello said Asian local currency bonds offer a distinct carry advantage with an average yield of 4.25 per cent (as measured by the HSBC Asian Local Bond Index yield) as of the end of November, or a full 305 basis points over US Treasuries.

"We believe that this yield advantage will be an important driver of returns of Asian local currency bonds over the next 12 months, particularly as subdued inflation trends and robust current account surpluses limit prospects for (further) rate hikes by central banks across the region," he said.