Lockdown Will Take Toll on Malaysia’s Already Steep Yield Curve

(Bloomberg) -- Malaysia’s yield curve has raced higher over the past year and is now near the steepest since 2017. The return to a strict lockdown and delays to vaccine distribution mean it may have further to run.

The spread between the nation’s three-year and 10-year sovereign debt climbed above 90 basis points last week, up from just 16 basis points before the coronavirus selloff in March. The tighter lockdown announced Jan. 11 and the imposition of a state of emergency the following day, are likely to intensify concern that Malaysia will fall short of its growth and fiscal consolidation targets this year, pushing up longer-term yields.

The decision to impose new movement restrictions came after the government forecast daily virus cases could jump to 8,000 over the next few months. On Thursday, it announced it would extend the initial two-week period until Feb. 4 as the number of cases remains elevated. The previous lockdown that began last March was eventually extended four times until June.

While neighbors Indonesia and Singapore have started their inoculation programs, Malaysia is only scheduled to get its first delivery of vaccines in February. Malaysia isn’t a laggard, Minister of Science, Technology and Innovation Khairy Jamaluddin sought to stress last week, seeking to counter concern about the slowness of the country’s progress.

The lockdown and vaccine delays are helping to spur bets the central bank will cut interest rates again, adding to the yield-curve steepening pressure. While policy makers stayed on hold when they met this week, their statement cited downside risks and left room open for more easing.

‘Possible’ Cut

“The central bank emphasized that the stance going forward will be ‘determined by new data and information,’ which opens up the possibility of a rate cut in the second quarter if the vaccine rollout isn’t as smooth as envisioned,” said Wellian Wiranto, an economist at Oversea-Chinese Banking Corp. in Singapore.

Another curve-steepening factor can be seen in the reflation trade. Malaysia’s bonds are among the most vulnerable in the region to a rebound in U.S. growth, along with Indonesia’s, according to a Bloomberg study of major emerging-Asian debt markets. This is because of their sensitivity to Treasury yields, which have more than doubled since August.

There are some positives for Malaysia’s longer-term bonds too.

While the government announced a 15 billion ringgit ($3.7 billion) pandemic relief package on Monday, it is likely to be financed through the reallocation of existing funds rather than through new sources of finance, according to analysts at United Overseas Bank Ltd. and Affin Hwang Investment Bank Bhd. This should ease concern about greater issuance of long-term bonds.

Investor demand for the securities at auctions also remains relatively steady. A 4-billion-ringgit sale of benchmark 10-year bonds on Thursday drew a bid-to-cover ratio of 2.0 times, up from 1.99 and 1.73 at the previous two offerings of that maturity last year.

Still, while it is possible to argue that the steepening move may be drawing to a close, uncertainties about the lockdown and the delays in widespread inoculation suggest that investors may find it wiser to stay clear of Malaysian longer-maturity bonds until an apparent recovery runway comes into view.

What to Watch

• The Philippines will release fourth-quarter GDP data on Thursday, after the economy contracted in each of the previous three quarters
• Malaysia will publish trade figures on Friday following three straight months of export growth
• Thailand will announce balance-of-payments numbers for December on Friday, after the nation registered a current-account deficit the previous month for the first time since May 2019

Note: Marcus Wong is an EM macro strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice