Bond valuations look attractive in a rising rate cycle
Bank Negara Malaysia raised the overnight policy rate (OPR) by 25 basis points to 2% on May 11, 2022, which was a surprise move compared to statements by the Monetary Policy Committee (MPC) in March, where he kept rates unchanged and seemed dovish.
The increase in the May 2022 OPR appeared to suggest that Bank Negara’s action was in line with that of other central banks based on the latest positive national growth indicators, while the gross domestic product (GDP) of the Malaysia in the first quarter of 2022 was 5% year-on-year. y/y/3.9% q/q, beating consensus at 4% y/y/2.5% q/q, and much better than 4Q21 GDP of 3.6% y/y/4.6% y/y quarterly shift. The sustained reopening of the global economy and improving labor market conditions continue to support the resumption of economic activities.
Inflationary pressures have risen sharply, due to rising commodity prices, tight supply chains and, in particular, the Ukraine-Russia war. As a result, several central banks in advanced economies are normalizing their interest rate policies much more quickly in order to reduce the impact of inflationary pressures and catch up with the US Federal Reserve’s tightening regime. Despite an increase in the policy rate, the bond market saw a recovery of relief after the first increase in the RPO since July 2020, as the possible increase in the RPO had already been priced in by the local bond market since the liquidation of the market until May 2022, before the tariff decision.
When it comes to government securities, we recommend watching this space closely, as US and Malaysian selling in government securities could eventually see a rebound in bond prices as more economists are revising global growth rates down for 2023 and beyond. This could be a good place for bonds, as it may also mean that we are nearing the end of the rate hike. We see these early signals in the US yield curve, where the US economy may be slowing, and this should benefit the government bond market as it trades closer to key rate moves.
On July 6, 2022, Bank Negara further raised the OPR by 25 basis points to 2.25% during the meeting of the Monetary Policy Committee and is expected to do the same during its next meetings in September and November, but we estimate that these increases have generally been gradual and not at an accelerated pace as in the United States or in advanced economies. The economic landscapes of the two countries are different and therefore the amount of their policy rate increases would also be different. For corporate bonds, we continue to like the AA-rated space due to the credit spread provided which is higher than the yield on government securities, which would improve the bond portfolio.
Opportunities in Asian Bonds
Outside of Malaysia, we remain cautious on other Asian markets, due to tighter financial conditions in the US and globally, which generally leads to less appetite for emerging market (EM) assets. ), although the spread differential favors Asia. That said, we remain positive on Chinese local government bonds, as this is the only developed market where the People’s Bank of China (PBoC) is on an easing trajectory. Yet few Asian countries are weathering this crisis better than many other emerging countries around the world, supported by improving credit fundamentals.
In Asia, we favor investment grade over high yield, although the high yield approach is opportunistic in nature and on a selective basis, as it has been severely oversold. We tend to stick with names that have a stronger brand image, where land reserves are in Tier 1 and -2 cities. However, the Tier 3 cities we like are those involved primarily in fast-growing economic regions with proven sales execution and access to finance.
Despite all the negative sentiment in the Chinese real estate space, we think the tide is starting to turn, although it will take some time for this sector to perform. The Chinese government has started to change the tone of its real estate policy by introducing various easing measures. On April 15, 2022, the PBoC announced a broad-based 25 basis point cut in the reserve requirement ratio for all banks, the third RRR cut since July and December 2021, injecting 530 billion RMB ($83.2 billion ) liquidity in the interbank system to help support the economy. . This was followed by a bigger than expected drop in the five-year prime lending rate on May 19, 2022, a key benchmark for mortgages. The rate fell 15 basis points to 4.45%, the biggest drop on record.
In light of these developments, we expect a meaningful recovery in the second half of 2022. We believe that the remaining high-quality, resilient developers could benefit from this recovery, as they have no imminent refinancing needs and have access to alternative funding channels.
Stay invested to protect against inflation
Therefore, in all asset classes, be it bonds or equities, the key to remember is to stay invested to hedge against inflation risk which is still acute at this stage. Bonds would be in demand if global growth continues to slow as it grapples with supply-constrained inflation. The need for income could once again be the dominant theme and in the investment playbook once average policy rates peak globally.
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