Published February 24, 2009

Buy 3-yr KL bonds, get fixed-rate swaps

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(SINGAPORE) Investors should purchase Malaysia's three-year government bonds and receive a fixed rate of interest in swaps as the central bank is likely to cut borrowing costs, according to DBS Group Holdings Ltd.

DBS forecasts the note's yield will fall as much as 35 basis points to 2.45 per cent in the weeks ahead as Bank Negara Malaysia will lower its overnight rate to 2 per cent from 2.5 per cent today.

Yields surged in the past two weeks, reaching the year's high of 2.95 per cent on Feb 18, after the central bank said it had 'frontloaded' its policy at the last meeting on Jan 21 and too low rates were 'not constructive' for the economy.

'The sell-off at the front end of the government bond curve is overdone,' Jens Lauschke, a fixed-income strategist at DBS in Singapore, wrote in a research note yesterday. 'As the economic outlook is weak, the policy rate is unlikely to remain at 2.5 per cent.'

The yield on the 3.833 per cent note due in September 2011 jumped 19 basis points, or 0.19 percentage point, last week to 2.8 per cent, according to Bursa Malaysia Bhd. It may drop to between 1.85 per cent and 2.45 per cent based on a central bank policy rate of 2 per cent, Mr Lauschke said.

Investors would earn a 1.5 per cent return in a month should the three-year yield decline to 2.25 per cent, according to Bloomberg calculations.

Futures contracts on the three-month Kuala Lumpur interbank offered rate, or Klibor, show borrowing costs may bottom out at 2.3 per cent in the second half, suggesting investors are no longer looking for steep rate cuts from current levels, DBS said.

Investors should enter interest-rate swaps to receive three-year fixed-rate payments in exchange for floating rates because the market is under-pricing the probability of rate cuts, Mr Lauschke said. The swap rate may decline to 2.25 per cent from the current 2.71 per cent in the weeks ahead, he said.

With the three-year fixed rate higher than the three-month Klibor and the market no longer looking for substantial policy easing, 'the risk-reward for this trade is good', he said. -- Bloomberg