Malaysian assets could be under pressure if Fed, BoJ tighten

KUALA LUMPUR: Malaysian markets could face near-term pressure from the outflow of hot money in the short-term, if the US Federal Reserve and the Bank of Japan (BoJ) decide to raise their policy rates this week.

Market observers said risks are on a weaker ringgit, higher bond yields, foreign equity outflows and valuation pressure on rate-sensitive sectors, particularly real estate investment trusts (REITs), property and high-growth technology stocks.

However, Malaysia's strong domestic growth, institutional support, defensive sectors and artificial intelligence (AI)-driven export demand could provide some cushion, they say.

MBSB Research head of research Imran Yassin said simultaneous tightening by the US and Japan would create a less favourable liquidity environment as the Fed raises the cost of US dollar funding while higher Japanese rates increase the cost of yen borrowing.

This could encourage some global investors to reduce leverage and exposure to Asian risk assets, including Malaysian equities.

"The greater risk comes from the unwinding of yen-funded carry trades, particularly if the BOJ hike causes the yen to strengthen more rapidly than expected," he said.

However, he expects Malaysia to remain relatively defensive because of its lower-duration market structure, domestic institutional liquidity and exposure to banks, plantations and defensive companies.

"Therefore, the base case is an orderly regional pullback, with a more severe sell-off occurring only if the Fed or BOJ delivers unexpectedly hawkish guidance or if yen appreciation causes a disorderly deleveraging cycle," he said.

The US Fed is expected to raise its federal funds rate by 25 basis points at its federal open market committee (FOMC) meeting on Wednesday. Currently, the rate sits between 3.5 and 3.75 per cent.

Meanwhile, the BoJ is also expected to raise its short-term policy rate again on Friday, after raising it to one per cent in June, the highest level in 31 years, as consumer inflation moves closer to the bank's two per cent target.

Bigger downside risk to Malaysian assets would emerge if the Fed or BoJ delivers more hawkish guidance than expected.

A more hawkish guidance from the Fed would prompt a sharper rise in US Treasury yields, while one from the BoJ would result in a stronger yen appreciation and a disorderly unwinding of yen-funded carry trades.

REITS, PROPERTY, HIGHLY-VALUED TECH STOCKS COULD BE PRESSURED

Imran added that equity valuations could undergo some compression as a higher global risk-free rate raises investors' required returns.

He said the impact would likely be strongest among expensive growth stocks and bond-proxy sectors, although the broader FTSE Bursa Malaysia KLCI should be cushioned by its relatively defensive composition and support from domestic institutional investors.

"An expected Fed hike should produce more of a sector rotation and modest valuation reset than a major market correction," he said.

Imran said REITs, property and high-valuation technology stocks would be the most vulnerable to an outflow of funds, given their sensitivity to higher bond yields, refinancing costs and discount rates.

In contrast, plantations, healthcare, consumer staples, selected exporters and cash-rich dividend-paying companies could prove more resilient.

He said exporters with US dollar revenue and predominantly ringgit-denominated costs could benefit from currency translation if the ringgit weakens, while plantations could receive similar support as crude palm oil is internationally priced.

Well-capitalised banks should also remain fundamentally resilient if domestic interest rates and asset quality remain stable, although their large index weightings could make them vulnerable to foreign selling initially, he said.

Bank Muamalat Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said the Fed's decision itself may have limited impact on markets, with investors instead likely to focus on its forward guidance for clues on the pace of further tightening.

"I think the markets have already priced that in. Hence, it may not be as bad as what people would think.

"I suppose the market wants to see the latest forecast, whether there will be more rate hikes for this year and next," he told Business Times.

Afzanizam said recent movements in Malaysian Government Securities (MGS) and Government Investment Issues (GII) also suggested that investors had already factored in some of the expected tightening.

"The question now is whether the Fed wants to play catch-up and whether they are really behind the curve in raising the rates," he said.

Meanwhile, Imran of MBSB Research said the immediate impact on Bursa Malaysia should be mild rather than disruptive as the expected Fed hike has largely been priced in.

"There could still be some short-term foreign selling as US Treasury yields rise and global portfolios rebalance towards US-dollar assets.

"The ringgit may also experience temporary pressure, but a sharp, sustained outflow is unlikely unless the Fed signals that several additional rate increases are forthcoming," he said.

LONGER-DATED MALAYSIAN BONDS MORE VULNERABLE THAN EQUITIES

Quintex Intel global strategist Stephen Innes, meanwhile, said longer-dated Malaysian government bonds could be more vulnerable than equities if US Treasury yields rise further following the Fed decision.

"Longer-dated Malaysian bonds would probably be more vulnerable than equities, particularly if US Treasury yields continue higher," he said.

Fed hike could initially pressure the ringgit, lift Malaysian bond yields and weigh on equities, although much of the impact could already be reflected in asset prices, said Innes, but noted that the US dollar has not been trading bullishly, as foreign exchange markets are not expecting the Fed to embark on a lengthy hiking cycle.

Meanwhile, simultaneous tightening by the Fed and BoJ could pose a greater risk to Asian markets by tightening global liquidity and accelerating the unwinding of yen-funded carry trades.

"That could create an initial risk-off move across Asian foreign exchange, bonds and equities. But I would frame this as a broader hawkish central-bank repricing rather than simply a Japan story," Innes said.

The yen carry trade involves investors borrowing yen at relatively low interest rates to invest in higher-yielding assets elsewhere.

Higher Japanese rates can reduce the attractiveness of such trades and potentially trigger the repatriation of funds.

Innes said Malaysia could be relatively better insulated, given its commodity exposure, artificial intelligence (AI)-linked export story, domestic growth and Bank Negara's more hawkish stance.

"Unless markets begin pricing a prolonged Fed tightening cycle, I would not expect the dollar to trade aggressively higher against the ringgit," he said.

Rakuten Trade Sdn Bhd head of research Kenny Yee said a substantial amount of outflows had already taken place from Malaysian equities over the past few weeks.

"I reckon the unwinding has already started amongst some countries where rates are expected to be steady. As for Malaysia, recent massive foreign outflows from equities could be an indication," he said.

Afzanizam said the ringgit could remain around its prevailing levels, supported by Malaysia's robust economic growth and relatively contained inflation.

"My sense is that the ringgit would linger at the prevailing exchange rate. The economy and markets remain dynamic and that includes monetary policies," he said.

He added that there was also a possibility of interest rate normalisation in Malaysia, which could provide further support for the ringgit.