The State of the Economy, Post 2Q2016

Investments, be it bond, equity, multi-assets in foreign countries are exposed to special risks, including currency fluctuations, economic instability and political developments. In certain economies, however, the heightened risks are due to limited number of players in the market, lesser liquidity and lack of business or economic frameworks to support the market. Acknowledging that the investments are susceptible to these risks and uncertainties, therefore it is important to be aware of the happenings in the world.


No one has thought that Brexit would actually happened came morning of 23rd June, but happened it did. Now it’s the time for Britons to wake up and face the consequences.

Post Brexit we could see switching activities happening in the fixed income market, where investors sold their Euro/UK sovereign holdings and went down the credit curve hunting for EM bonds. This activity has indicated investors reaction towards uncertainties in the market and their search for higher yield but relatively safe investments. EM economies have fared better than 2015 due to slight rebound in commodities’ prices, currencies strengthening, and better economics numbers. Post Brexit we could also see that EM had experienced minimal volatility, signalling that the EM economies are sheltered from the downside risks imminent in the Eurozone and have thus far performing more in line with their economic fundamentals.

This is important, especially after disappointing returns since 2013, the investors are pondering the possibilities that the market is set for better EM returns over the next few years.

UK, with its stagnant economics, currently runs the highest current account deficits in the developed world. Now that there’s no turning back for UK, we could anticipate a breakup in the country via Scottish and Irish referenda. Market believes that there is a higher chance for BoE to further cut rates and ECB to extend its QE this year.

Question is, will there be a EU breakup?

Failed coup d’état

There was an attempt of coup in Turkey on 15th July and it has been thwarted and the Turkish government has had full control of the situation on Saturday. That said coup was not the first to Turkey as there have been multiple coup attempts in the past 60 years

As for sovereign risk, the event has sparked more downside risks to the government bond and credit ratings. The rating agency, Moody’s, will have its Turkish rating review on the 5th August, in which if they decide on a downgrade, it would then push the sovereign rating to junk, from the current Baa3/Negative. Both S&P and Fitch rated Turkey as BB+/Stable and BBB-/Stable.

Finally, a cut!

On the domestic front, there was an overnight policy rate cut, a first since July 2014. It was during the monetary policy committee meeting held on 13th July where the new central bank governor has decided to cut benchmark policy rate by 25bps to 3.00%. The cut happened post Brexit, where it was likely that the central bank took advantage from the delay in the Feds interest rate normalization policy.

However, this cut also came as a surprise for many, as economists predicted the cut to materialise in September or later, due to minimal forward guidance to indicate that such a hike was imminent.

Major indicative reasons for the cut; subdued inflation where it gives policy room for loosening, downtrend in consumer and business confidence as well as low and stable inflation in the environment of low global energy and commodity prices. Immediate impact post OPR cut could be seen on sovereign bond where the mid to long tenor had seen the biggest yield drop, resulted in bullish flattening of the yield curve. However the impact was not large per se, as the market has earlier priced in the possibility of rate cut, where yields have fallen by 30-60bps across the curve ytd. Ensuing this, the corporate bond’s behaviour may follow the fall in government bond yields.

Overall, adjustment to the OPR level is intended for the degree of monetary accommodativeness. After all, neighbouring countries in the region are also cutting the interest rates. Interesting thing to note that contrary to textbook theory, MYR has strengthened post cut. The reason could be due to inflows of foreign investments (mainly in the mid tenure of MGS) as the market is anticipating for further cuts in the following months.