Time to switch your strategy from Malaysian to Thai bonds

The slowdown in foreign inflows has been a key theme in Asian bond markets since February. Based on feedback from our recent Asian rates roadshow in Europe, real-money fund managers currently prefer bonds from Latin America and Eastern Europe over Asian bonds. They cited low bond yields in Asia; in addition, the slowdown in Chinese yuan appreciation has reduced appreciation expectations for other Asian currencies. Given higher local bond yields in Latin America and Eastern Europe and the lack of robust yuan appreciation, investors are shying away from Asian local-currency bond markets. Within Latin America, investors favour Mexico, as they see it as a high-beta play with the US. In CEMEA (Central Europe Middle East and Africa), investors favour Turkey, South Africa, Hungary and Russia due to high yields. 

Despite reduced foreign demand, we remain generally constructive on Asian bonds given strong local demand. We do not expect any central bank in Asia to hike rates this year, while governments’ bond issuance was generally ahead of run rates in the first four months of 2012. Thus, barring rate hikes or supply pressures, we expect local insurance companies, pension funds, banks and mutual funds to step in to buy if Asian bond yields correct higher.

We recommended that global bond investors switch out of Malaysian government bonds into Thai bonds, as we see the Malaysian bond market as more vulnerable if foreign inflows continue to moderate. Previously, global bond investors preferred Malaysian bonds over Thai bonds because yields on Malaysian bonds were around 30-40 basis points (bps) higher and the ringgit appeared more attractive than the baht due to yuan appreciation. However, after two to three years of persistent foreign inflows, the Malaysian yield curve is now flatter than the Thai bond curve, and Thai 10-year yields are 20bps above Malaysian 10-year yields. Moreover, with the yuan appreciation trend moderating, the outlook for the ringgit is less appealing. 

In terms of positioning, foreigners have been overweight duration versus their benchmark (GBI-EM Global Diversified) for the past few years in Malaysia, while they have been underweight duration versus benchmark in Thailand. This is reflected in data on foreign holdings, which shows that foreign holdings of Malaysian bonds make up around 39 per cent of the total outstanding, compared with just 13 per cent in Thailand. Thus, in the event that foreign inflows to Asia continue to decline, we see Malaysia as more vulnerable. 

Going forward, we expect global emerging-market bond investors to slowly switch from Malaysia into Thailand, which will prompt a pick-up in foreign bond inflows to the Thai bond market. 

 

Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.