November 2013 Monetary Conditions

Happy New Year!

I’ve taken a break from writing about Malaysia’s monetary environment for a few months now, as it was getting boring and a bit too much like work. But a lot has happened in the last couple of months, and things are getting interesting again.

Interest rates have taken a roller coaster ride since April 2013, when the rumours about the Federal Reserve planning a pullback in its QEIII program started circulating. Speculation has now turned to reality, though since the formal announcement occurred in mid-December, we won’t see the full impact until the December figures are in at the end of this month.

Nevertheless, heightened expectations might be responsible for the following (log annual and monthly changes; seasonally adjusted):

M1 growth was pretty stable, and the acceleration in growth is consistent with higher cash balances at the end of the year – BNM issued more currency, while demand deposits also rose. M2 growth however fell off a cliff, recording the slowest growth in annual terms since July 2009, and in monthly terms since March 2007.

The source of the contraction came from basically just two sources – a sharp drop in fixed deposits of about RM11.3 billion and a RM5 billion fall in repos. The only other component to see a decrease in absolute terms were NIDs, which together with the drop in repos is consistent with a tightening of liquidity conditions in the interbank market.

That may or may not be due to tapering talk. It might be, but if it is, it appears that foreign investors aren’t really driving this movement – foreign currency deposits actually rose, while foreign holdings of government securities was only slightly lower than in October (RM millions; ex-monetary debt):

Domestic interest rates certainly bolster the case that domestic participants are as jittery over Fed tapering as foreign investors are:

Spreads at the long end are rising – again consistent with tighter liquidity. The MGS market was even more dramatic:

Not only are yields up, but so are spreads:

Yields on benchmark issues are currently 5bp-15bp higher than shown in the charts above. Things are not as dismal as they were this summer, but its getting there – as the Carpenters song goes, “We’ve only just begun…”

Before anybody starts panicking however, bear in mind that the low yields and spread compression we’ve seen over the past couple of years are well outside the historical norm. Take the last chart above; if you extend it back to 2000, it’ll look like this:

So what we’re seeing is more akin to a normalisation process, rather than a descent into crisis. I’d hate however to try and forecast what interest rates will do going forward. The only thing I can predict is that volatility is probably going to increase as the market tries to figure out what the new norms will be.

Tighter liquidity does mean banks are becoming more cautious, but loan demand remains strong:

Credit has been tightening since 2Q2013 pretty much across all sectors (with the funny exception of passenger cars). This is more likely due to the new Financial Services Act which came into force in July, and BNM’s subsequent moves to improve bank asset quality, rather than the threat of a withdrawal of US monetary stimulus.

So we’re still early days yet in terms of assessing the impact of QEIII withdrawal (pun intended).

Technical Notes:

Data from the November 2013 Monthly Statistical Bulleting from Bank Negara Malaysia