This article first appeared in Capital, The Edge Malaysia Weekly on December 25, 2023 - December 31, 2023

Head

Franklin Templeton Asset Management (Malaysia) Sdn Bhd

Global financial markets were shaped by a few important trends in 2023, notably high inflation and central bank monetary policies. The US Federal Reserve hiked interest rates by 100 basis points (bps) in 2023 and as the year draws to a close, there are signs of softening in inflation, economic and employment data in the US. The US bond market staged a sharp rally, driven by mounting expectations that the US is approaching the conclusion of the current rate hike cycle with the market pricing in more than four rounds of 25bps interest rate cuts in 2024. Our base case scenario, however, is a soft landing with resilience in the US economy due to consumer support, which resulted in fewer rate cut expectations compared with the general market forecast.

Against the backdrop of an evolving financial market landscape, the Malaysian bond market has emerged as a beacon of resilience and stability in 2023. The domestic bond market began the year on a strong footing following Bank Negara Malaysia’s decision to maintain the overnight policy rate (OPR) in January. In March, the collapse of three US regional banks and UBS’ acquisition of Credit Suisse sparked concerns about an escalation of systemic risk in the global financial system. The flight to safety into US Treasuries (UST) further bolstered sentiment in the domestic bond market. However, a turning point materialised in the third quarter when stubborn US core inflation and hawkish speeches from Fed officials prompted a correction, propelling global and local rates higher.

Despite Bank Negara’s move to increase the OPR by 25bps in May, the resilience of the domestic bond market endured throughout the first half of the year, underpinned by favourable demand and supply dynamics. Malaysia was largely sheltered from spiking inflationary pressures in 2022 and 2023 due to heavy price controls on essential household items. Despite the weak ringgit throughout 2023, which usually causes imported inflation, the inflation rate was elevated but manageable. The latest inflation figure showed domestic headline inflation moderated to 1.8% year on year in October, down from the 3% level observed in the first quarter. The disinflationary trend provided further impetus for the local bond market.

However, we expect inflation to remain a key theme in 2024 with the rollout of petrol subsidy rationalisation. Our base case is for the subsidy rationalisation to be done in a gradual manner. Therefore, we think the OPR should remain stable at 3% in 2024.

To recap, until December 2023, the year proved to be a good one for our domestic bond market as Malaysian government bonds delivered a total return of 5.8%* (as at Dec 8, 2023), which compares well against the total return of 1.5% for the full year of 2022.

Looking ahead

Approaching 2024, we expect another year of positive returns for the Malaysian bond market with expected stability on the OPR and government policy fronts. As announced in Budget 2024, we expect lower net government bond supply in 2024 in line with lower fiscal deficit targets, against healthy demand from local pension funds and asset managers for government bonds. This is supportive of the local bond market.

However, we still expect headwinds on two fronts — locally, the timing and pace of petrol subsidy rationalisation, and globally, the expected volatility in UST yields as the market is somewhat split on the pace of rate cuts to the federal funds rate in 2024. As such, we expect to see volatility in UST yields as markets push and pull between bulls and bears. We often see a spillover of such trends into the local market, as seen over the last three years. Variability in macro trends will create blocks of trading opportunities in 2024.

While economic outlooks differ, peak interest rates present an opportunity for fixed-income investments, especially at the longer end of the curve. The downside of holding cash is that if rates drop, cash yields will also drop. So, moving into fixed income now allows investors to “lock in” higher interest rates.

Corporate bonds should perform as well as companies take advantage of stable interest rates and tight credit spreads to fund capital expenditure requirements. The narrow credit spreads are likely to persist going into 2024 as demand for investment-grade corporate bonds remains high among investors. We favour companies that are not highly leveraged, and cherry-picking is essential to untangle those with higher credit risk from the rest of the herd.

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