KUALA LUMPUR: Malaysian Government Securities (MGS) yields and foreign fund flows could face renewed volatility following this week's US Federal Reserve meeting, as investors assess the implications of its policy outlook for global bond markets.
Economist Professor Geoffrey Williams said a US rate increase could put some upward pressure on MGS yields, although the impact would likely be limited because Malaysian government bonds were predominantly held by domestic investors.
He added that the move could also weaken the ringgit, although he viewed some depreciation as potentially necessary.
Trade View analyst Neoh Jia Man also expects the Fed to maintain interest rates, citing elevated energy costs linked to Middle East tensions and signs of a cooling US labour market.
"The Fed may see this as temporary. At the same time, the labour market is cooling, especially in hiring. Having hiked only last month, we think the Fed will wait for more data," he said.
Neoh said the 10-year MGS yield had fallen by more than 20 basis points from its mid-September peak, suggesting the market had largely priced in a Fed rate hold.
However, he warned that a surprise rate hike or a more hawkish policy outlook could push up short-term MGS yields and accelerate foreign fund outflows.
Equities could also face pressure from such outflows, although Neoh said valuations in certain sectors had become attractive and remained supported by strong fundamentals.
With a rate hold widely expected, Innes said Malaysian markets would likely take their direction less from the actual decision and more from movements in US Treasury yields.
"If those concerns drive US Treasury yields lower, MGS could benefit from improved relative value and renewed foreign interest," he said.
However, he cautioned that the benefits could be offset if falling yields reflected deeper concerns about an unwinding of AI investment, potentially triggering broader risk aversion and weakening foreign equity flows.
RAM Ratings, in its Mid-Week Bond Market Update dated Oct 22, identified the Oct 27-28 Federal Open Market Committee (FOMC) meeting as a key external catalyst for Malaysia's bond market.
The rating agency warned that changes in US monetary policy guidance could trigger a repricing of US Treasury yields, spilling over into MGS, particularly longer-dated securities.
The 10-year MGS yield edged up to 3.92 per cent on Oct 21 from 3.90 per cent a week earlier, while the corresponding US Treasury yield fell to 5.13 per cent from 5.19 per cent.
The yield differential between the two benchmarks narrowed to negative 120.6 basis points on Oct 21 from negative 128.8 basis points on Oct 14, modestly improving the relative yield appeal of Malaysian government bonds.
However, foreign investors recorded a net outflow of RM570 million from Malaysian government bonds in the week ended Oct 14, despite overall foreign bond holdings registering a marginal net inflow of RM30 million.
The overall inflow was supported by RM610 million in corporate bond purchases, which offset the outflow from government bonds.
RAM Ratings said Malaysia's headline inflation eased to 1.8 per cent in September from 1.9 per cent in August, reducing the urgency for a policy rate hike.
"Attention now shifts to the Nov 5 Monetary Policy Committee meeting, with Bank Negara's assessment of inflation and domestic demand strength relevant for short-end MGS pricing," it said.
Williams expects a modest increase in US interest rates, citing strong demand and the risk of inflationary pressure.
"I expect a small increase in US interest rates because there is strong demand and their conventional approach will be to raise rates in anticipation of inflation," he said.
SPI Asset Management managing director Stephen Innes, however, expects the Fed to maintain interest rates at its upcoming meeting, saying financial conditions have already tightened amid pressure on equities and waning enthusiasm for artificial intelligence (AI)-related stocks.
"Inflation remains uncomfortable, particularly with oil prices elevated, but financial conditions have already tightened considerably as equities have come under pressure and the AI trade begins to lose some of its shine," he said.
Innes said the sustainability of AI investment spending had become an increasingly important consideration for bond investors, given the substantial financing requirements behind the boom.
He said a slowdown in AI capital expenditure could weigh on US economic growth, reducing the need for further monetary tightening.
"For now, patience is the sensible option. The Fed can afford to sit on its hands and see whether inflation or weakening growth wins this particular tug of war," he said.
Bank Negara expected to maintain policy rate
On domestic monetary policy, Williams expects Bank Negara to keep its policy rate unchanged, using other measures to manage financial markets if needed.
Neoh said a Fed rate hike or a more hawkish stance would increase the possibility of Bank Negara raising rates, although he expected such a move to be more likely next year than this year.
"Inflation is still benign, consumer sentiment is weakening, and the ringgit is stable against the US dollar. Hence, we expect Bank Negara to keep the overnight policy rate unchanged unless domestic data change substantially," he said.
Innes also expects Bank Negara to remain patient, citing resilient domestic growth and relatively contained inflation.
"For Bank Negara, the sensible approach is to remain patient. Domestic growth has been resilient and inflation relatively contained, so there is little urgency to move the policy rate in either direction," he said.
He added that the Fed would remain an important policy reference for central banks, including Bank Negara, as they navigate persistent inflationary pressures alongside risks to global growth.
"I think the Fed will remain the main policy anchor for many central banks, including Bank Negara, as they navigate this increasingly narrow passage between inflation and slowing global growth," he said.
Innes added that elevated oil prices continued to pose inflationary risks, while a potential slowdown in AI investment could weaken demand and employment, complicating the outlook for central banks.
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