When Growth and Inflation Collides

Technorati Tags : Malaysia bond market, inflation and growth

The focus last week was on the Monetary Policy Committee (MPC) meeting held on Monday. Although BNM decided to leave the OPR unchanged at 3.50% for the 17^th consecutive meeting, the accompanying Monetary Policy Statement (MPS) was hawkish towards the upside risk to local inflation. For the first time, the central bank indicated that it would undertake the appropriate monetary measures should the balance of risks shift towards inflation. The change in the MPS language sparked the sell down in bonds throughout the week.

Out in the news, Q1 GDP grew by 7.1%, surpassing consensus estimate of 6.5% due to the strong domestic consumption and exports. The statement by the Second Finance Minister that the government is confident of achieving its target growth of 5-6% in 2008 without special stimulus measure added more selling pressure to the bond market as players started to toy with the idea of a rate hike given the higher risk to inflation and resilient growth outlook. The risk would be greater if inflation were to persistently breach the 3% mark, and especially if fuel subsidies were rolled back sharply, which could bring full year inflation closer to the 4% mark.

Government Securities

The hawkish MPS and better than expected Q1 GDP were the main catalysts to higher yields across the MGS curves last week. Selling pressure was imminent throughout the week as sentiment tilted towards the upside risk to inflation from the previous balanced inflation and growth outlook. The average daily trading volume increased to RM1.1 billion from RM727 million recorded last week. The highlight of the week was on the re-opening of the current 5-year benchmark MJ07/13 amounting to RM3.5bn. The When Issued was traded between the range of 3.85%-3.67%. The stock was auctioned at the high and low of 3.85% and 3.78% respectively with the average seen at 3.802%. Demand was poor from real money investors, judging from the low bid to cover ratio of only 1.45 times. Post auction, the stock closed at 3.85%, 5bps higher than last week’s level. The 3-year MJ09/11 received little attention last week and closed 9bps higher to 3.62%. On the other hand, the 10-year MS02/18 was actively traded in a volatile week. The stock was sold to a high of 4.08% before easing at 4.00%, 5bps higher than last week’s closing. The 20-year MX05/27 rose 9bps to close at 4.36%.

In terms of sovereign spreads, the 3/5s widened by 5bps to 20bps. The 5/10s narrowed by 9bps to 18bps while the 10/20s inched higher by 4bps to 36bps.

The Week Ahead

We foresee the selling pressure to continue and sentiment will remain bearish in line with higher regional rates. Speculation on the timing of fuel subsidy reduction as well as the uncertain political drama will add further twist to the week ahead.

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