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Yield
Economics – Markets – Strategy
MGS yields are
likely to rise
further in the
near-term
Malaysia: Policy risks now clearly towards rate hikes
As we had expected, bond yields rose in 2Q08 as the market moved to reflect and
compensate for inflation risks following comments from the government in May
that it will seek ways to increase fuel prices. Concerns that subsidy adjustments
would stoke inflation and prompt rate hikes sent yields higher (Charts 27 & 28).
MGS yields are likely to rise somewhat further in the near-term, after subsidies
were adjusted earlier this month.
With petrol prices having been raised by 41% and diesel prices 63% higher, our
projections show that headline CPI inflation is expected to rise sharply to about
5.8%YoY in June, which should lift full year inflation to about 4.5%YoY. The
impact on growth will be mixed. Overall growth is expected to moderate to
5.1%YoY for the year, down from our previous forecast of 5.8%YoY.
We now think that policy tightening is needed to anchor inflation expectation
and to prevent second round effects of the price increases. We expect Bank Negara
to hike its policy rate by 50bps to 4% at the next policy meeting in July and then
hold at that rate well into 2009.
With rate hikes being discounted at the front end of the yield curve and investors
being better compensated for inflation risks, we believe yields are unlikely to rise
much further from current levels. In fact, given that we only expect a one-off
adjustment in policy rates, receiving positions in onshore swaps look attractive.
Interestingly, MGS yields have not risen as sharply as swap rates, which suggests
long positions in bonds are not as attractive as receiving positions in swaps. MGS
yields could rise further.
Chart 27: 3Y MGS Yields vs 10Y MGS Yields
%pa
5.5
5.0
4.5
4.0
3.5
3.0
Spread (RHS)
MGS 10Y
MGS 3Y
bps
150
125
100
75
50
25
Chart 28: O/N Policy Rate & Klibor 3M vs MYR IRS
% pa
O/N Policy Rate
5.0
Klibor 3M
MYR IRS 1Y
MYR IRS 2Y
4.5
MYR IRS 3Y
4.0
3.5
3.0
2.5
0
May-05 May-06 May-07 May-08
2.5
May-05 May-06 May-07 May-08
India: Still a rate hike story
The direction of gilt yields remains a tough call, but we remain comfortable with
our rate hike forecast. We expect another rate hike of 25bps in the repo and
reverse repo rates before year end. Inflation risks are even more prominent now
after the hike in diesel and petrol prices earlier this month and the growth outlook
is not weak enough to keep the RBI on hold.
On the Inflation front, WPI inflation stands at a 3.5-year high of 8.1%YoY and is
likely to rise above 9%YoY as the fuel price adjustments should push inflation
higher by 1 percentage point (Chart 29).
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