THE yields of Malaysian Government Securities (MGS) have shot up in the past one month, even as the ringgit continued to touch new lows, breaching 4.18 against the US dollar last week.

Five-year MGS yields, for example, were among the most volatile, shooting up by almost 59 basis points (bps) from July to as high as 4.048% on Aug 17, before settling at 4.010% last Thursday.

This has begun to put upward pressure on yields for new issuances, both for the government as well as corporates. Rising yields are not good for these entities because it drives up the cost of borrowing.

At the same time, funds and investors holding the bonds for a long while will make a loss as the mark to market value of their portfolios is written down.

On the other hand, the slowdown in issuances this year means that there is still plenty of liquidity on the sidelines, albeit waiting for the right yields.

Genting Malaysia Bhd, for example, had little trouble raising about RM2.4 billion in AAA-rated five- and 10-year notes at slightly higher coupon rates of 4.5% and 4.9% respectively.

“Rising yields in MGS as well as PDS (private debt securities) markets currently definitely lead to higher yields in the primary markets. Genting Malaysia’s new issuance yield is relatively higher than new issuance yields two to three months back. Due to higher yields offered by highly rated issuers, demand for this paper is still there despite the risk-averse environment,” explains Liu Hing Luen, who heads fixed income research at Etiqa Insurance & Takaful.

Going forward, all eyes will be on a 10-year MGS (expiring September 2025) that will be reopening next week, where the government is expected to auction some RM3 billion in MGS. The results of this auction — bid to cover ratio and the yields’ bid — will give an indication of the direction of the market.

“PDS yields have somewhat corrected in response to recent movement in “govvies” (government bonds) but I do not see a further jump in yields with the assumption that there is a good chance our government yields will settle down at a lower level again, once the heat on the ringgit cools off,” says Esther Teo, head of fixed income at Affin Hwang Asset Management Bhd.

New issuances have been hard to come by this year, she says, pointing out that issuances like Benih Restu and Kuala Lumpur Kepong Bhd (KLK) had to be upsized and saw yields being suppressed due to high demand against a limited supply of paper.

“In other words, high demand for paper is balancing out a rise in yields,” she explains.

Genting Malaysia’s MTN programme, for example, was originally set to raise only RM2 billion. However, when it received RM2.4 billion worth of bids, both the issuer and the bidders opted to have the full RM2.4 billion amount issued instead.

“Usually, the bid to cover ratio will exceed the amount the company is trying to raise. But due to the lack of issuances, they agreed to expand the issuance and raise more money,” explains a fund manager.

Interestingly, strong local demand for new issuances hasn’t managed to keep MGS yields in check. The main reason for this is persistent foreign selling due to the weaker sentiment, say analysts.

“I believe Malaysia’s economic fundamentals are still intact but external headwinds are putting pressure on not just Malaysia but overall emerging market currencies. However, Malaysia is feeling more heat due to other factors,” says Teo.

The falling ringgit doesn’t help build a case for foreign investors to hold MGS either. Last week, the ringgit fell another 2.2% to close at 4.1685 against the US dollar.

“Foreign investors seem very concerned with the weakening ringgit and the falling foreign reserves number but investors must bear in mind that these two factors are very much inter-related. That is, in the current situation, if they want to see the ringgit being defended, they have to be prepared for lower reserves, and vice versa,” notes Teo.

Bank Negara Malaysia’s international reserves shrank to US$94.5 million as at Aug 14, indicating that the central bank has not been defending the currency aggressively.

That said, Teo isn’t too concerned about the selling on MGS.

“We are not experiencing continuous selling; there are still foreign investors who see value in our bonds as well as surplus local funds. Some of the benchmarks are oversold (which is very attractive and should be snapped up by funds) while some that were overbought in the last months are just correcting to fair levels,” she explains.

She points out that yields are starting to look very attractive, given that benchmark indices are either at par or higher than 2009 levels, during the early stages of the global financial crisis.

“The selling of MGS was very much sentiment-driven, not fundamental-driven,” adds Teo.

That said, Malaysia’s credit default swap (CDS) rates, the cost of insuring Malaysian sovereign debt, has also been on the rise, outpacing its regional neighbours.

CDS rates are a market’s measure of the country’s sovereign risk; the higher the number, the higher the perceived risk. However, since it is driven by market forces, CDS tend to be volatile as well.

Malaysia’s five-year CDS shot up to 184.698bps last Friday, up almost 36.71bps from the beginning of the month. Notably, CDS rates have been on the rise for the entire region, with those of Thailand, Indonesia and the Philippines closing at of 156.999bps, 233.931bps and 115.257bps respectively.

Taking a closer look at the selldown, Liu attributes the foreign selling pressure at the short end of the curve (bonds with shorter tenures) to relatively higher foreign holdings.

“Three-year MGS has had relatively higher foreign exposure [recently compared with previously] after Bank Negara stopped issuing short-term bills for some months,” says Liu.

Furthermore, the weakening ringgit resulted in negative carry (where holding cost exceeds yield) vis-à-vis the overnight policy rate (OPR), he explains.

On the long end of the curve, Liu points to the higher-than-expected RM3.5 billion reopening of 10-year government investment issues (GII).

“Foreigners had raised the overall MGII exposure to a record RM10 billion in June, thus, there was circa RM1.6 billion reduction in MGII foreign exposure in July,” he explains.

At the same time, local fund managers are using the spike in MGS yields as a buying opportunity.

“When the market moves based on sentiment, it tends to swing like a pendulum and it tends to swing too far in one direction. But eventually, it will have to swing back in the other direction. In the meantime, the rise in MGS yields has created a good buying opportunity for local funds that look at the fundamentals,” explains a fund manager who is more optimistic.

Malaysia still has an A-rating, he notes, while pointing out that the CDS numbers are highly distorted by the weak oil prices.

“For the kind of credit rating that we have, and the kind of GDP growth that Malaysia is generating, I think the yields look very good. While foreigners will be turned away by the weak ringgit at the moment, the currency will have to stabilise and come back down [strengthen] at some point. When that happens, the bond yields will fall again,” he explains.

This article first appeared in Capital, digitaledge Weekly, on August 24 - 30, 2015.