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The week started with a literal bang, thanks to the escalation of conflict between Israel and Palestine, coupled with the involvement of Hezbollah. Global markets opened risk off on Monday morning, led by a 4% gap higher in oil and a 1% drop in SPX500 futures. As is typical for risk-off type behaviour, gold and treasuries were bought up, with 10y yields falling 16bps to 4.64% on Monday itself. As the week went by and the market digested the conflict though, some of those moves were retraced, with oil actually reverting to the previous Friday’s levels at one point.
Going into the US CPI print on Thursday, a bevy of Federal Reserve speakers were speaking on monetary policy. The message that the market took away was that the rise in longer end rates could reduce the need for further rate hikes from the Fed. This in turn caused 2 year treasury yields to fall in bull-steepening fashion, which helped stem some of Monday’s risk-off rout in equities.
The US CPI print on Thursday took the wind out of those sails though. A hotter than expected print (3.7% YoY vs. 3.6%) and a notable uptick in core and super core measures pushed back on the Fed’s argument. While initially slow to react, 10y yields rose 14 bps back to 4.70. At one point, the Fed Fund Futures implied a Dec hike probability of 50%, but this has since settled back closer to 40%.
Into Friday’s market close however, tail-risk hedging started to become a focus. Israel had given an evacuation warning to Gaza inhabitants to flee the city within 24 hours (though this deadline has since been verbally loosened), in an indication of a serious offensive action to come. The market took this negatively, producing a sharp reversal in US indices and a serious spike in both oil and gold prices. Brent crude closed Friday up 5.4% on the day, with gold not far behind at 3.4%. The Dollar gained broadly, particularly against high beta currencies like AUD and NZD.
Most notably though, the VIX index jumped 3.2 handles to close at 19.3, while also making an intraday high at 20.78. That’s a whopping 20% increase and a huge change in volatility of volatility terms. That should be an indication of the level of worry the market has going into the weekend.
In its Budget 2024 announcement, the government stated its aim to reduce the fiscal deficit to 4.3% of GDP in 2024 while 2023’s deficit is expected to come in line with the official target of 5.0% of GDP. This path to fiscal consolidation clearly considers the need to not to affect growth prospects considering the Malaysian economy is already facing headwinds.
Subsidy rationalisation took its first baby steps with chicken, eggs, electricity and diesel to undergo a phased reduction which may pave the way for broader subsidy reform. Lest we forget, Malaysians enjoy a cheaper RON95 price even when compared to Saudi Arabia. The hefty subsidy bill of RM70bn in 2022 is set to reduce to RM64bn in 2023 and RM53bn in 2024.
Conspicuously, mention of subsidy rationalisation for RON95 petrol, one of the largest subsidised spend items, was scarce, but we expect this progress to gather steam in 2024.
The revenue side was addressed not by GST but instead with:
1) Raising the services tax from 6% to 8%, with some key sectors exempted such as food & beverage and telecommunications.
2) Capital gains tax of 10% from the disposal of unlisted shares for companies (implying not applicable for individuals) from Mar’24.
3) Luxury tax of 5 - 10%.
When balanced out by some lower revenue factors (e.g. lower dividend from Petronas) the net revenue increase is expected at 1.5% to RM307.6bn in 2024.
Additionally, the Public Finance and Fiscal Responsibility Bill was passed by parliament on 11 Oct 2023. It sets out some key targets:
1) Government debt capped to 60% of GDP in the medium term (3 - 5 years)
2) Government guarantees capped at 25% of GDP
3) Fiscal deficit capped at 3% of GDP in the medium term
4) A floor for development expenditure set at 3% of GDP.
Into the budget tabling this Friday, local equities staged a rally after being beaten down for most of last week, perhaps in anticipation of a market friendly budget. Thursday’s 10y MGII auction also received significant interest with a bid-to-cover ratio of 2.7 times, though mostly from local names. The wider bond market saw a strong recovery in government bonds across most tenures except for the short end in line with the fall in yields in the US amid the flight to safety. Corporate bonds did not benefit from such a rally just yet, with lower liquidity conditions to blame. In contrast, the Ringgit was neither here nor there, trading mostly in a range but sadly still near our all time highs.
After ending the previous week with some promise, Bitcoin reversed its trend to trade lower into the range once more. The previous support at 27000 gave way slightly to touch a session low near 26000 briefly, but from a price-volume perspective the equilibrium level within 26700-26900 is more reflective. The SEC’s decision not to appeal its loss in the Grayscale case was taken positively by the market, reinforcing the perception that a spot ETF would be a question of when, not if.
The rest of the crypto market has taken a beating though, amidst the risk-off environment and what seems to be the anti-correlation with traditional financial assets working against crypto this time (of course, correlation is not the same as causation). Ether was front and centre in this rout lower, amidst rumours that the Ethereum foundation was selling some of its reserves and low network utilisation turning the protocol mildly inflationary instead. Ether made a low of 1520 for the week before rebounding back above support at 1550, but still trades precariously close to that pivot level.
Within the crypto subsector space, the real-world asset tokenisation narrative continues to leads all others, with the focus primarily on yield bearing stablecoin derivatives. Frax Finance launched their sFRAX token, which is paying an initial yield of 10% to attract liquidity. Maker DAO, the OG in this space, has also brought sDAI to the Gnosis chain, with initial yields estimated at 11%. Naturally, the governance tokens of both protocols (FXS and MKR) have continued to outperform this week.
The sharp risk aversion shown into Friday’s market close will likely shape price action for the week ahead. The last time we saw something similar in terms of 1 day moves harkens back to March of this year, where the Silicon Valley Bank crisis was taking shape. Tail risk managers have highlighted that since then, short volatility ETPs have been gaining in popularity. If conflict escalates in meaningful fashion over the weekend, the derisking behaviour of market participants would have an adverse impact on risk assets.
Similarly, the bid in oil would continue to support inflation expectations. While the safety bid in gold and treasuries is working out for now, we see the impact much more acutely in gold vs. treasuries for now, as inflationary pressures from another large conflict take centre stage first.
We see the Budget 2024 announcement as a negative for the MYR bond market as it implies increased supply of government bonds in Q4 while also hinting at a lower supply of bonds in 2024. The short term drivers are resulting in a period of high volatility and hence uncertainty for the MYR bond market, and while volatility favoured those who took duration this week, it may not continue to be so kind in the future. Hence, we continue to advocate for a short duration position in MYR bonds and a great way to do so is via the Halogen Shariah Ringgit Income Fund with its T+1 liquidity.
Looking slightly longer term, we think the Malaysian government has done just enough to keep its sovereign rating in check. Malaysia is currently rated A- by S&P, A3 by Moody’s and BBB+ by Fitch. Alas, not enough has been done in terms of revenue generation or cost reduction to merit an upgrade.
We continue to see Bitcoin and the crypto complex being driven mainly by sentiments surrounding the ETF approval narrative, with the first SEC deadline coming this Monday Oct 16 and more of them landing throughout the week. Again, we think it’s more likely than not another delay is in store for us, but as more time goes by, we also think that any dips will get more and more shallow. Despite that though, the options market isn’t taking too many chances, with Friday Oct 20 options showing a large premium compared to the Monday Oct 16 expiry.
The broad risk aversion trade will also continue to weigh on the cryptocurrency space. In terms of a potential large derisking though, we don’t see as large of a potential spillover compared to traditional finance. Crypto markets have generally been driven by their own specific drivers, and speculative activity is still comparatively lower to that from the June-August period, where euphoria was high thanks to the Blackrock ETF filing. Looking once again at the options market, weekend volatility pricing remains low - indicating that despite the potential escalation in the Israel/Palestine conflict, there doesn’t seem to be a structural bid to cover short options positions.
We highlighted the DeFi RWA narrative in a previous editorial, and continue to watch that space with great interest. Maker DAO and Frax Finance continue to be interesting projects to watch, as first movers in the yield-bearing stablecoin segment of DeFi RWA. The higher for longer narrative stands to benefit these two initiatives. That said, we don’t think that the initial yields on offer will stay at these levels. Also, given that protocol risk remains the biggest risk to any attempt to participate in RWA type staking, such yields may not perhaps sufficiently compensate investors for the risk they need to take.
Thank you for reading and we’ll see you next week!
Team Halogen
Disclaimer: The information, analysis, and viewpoints presented here are intended solely for general informational purposes and should not be construed as personalised advice or recommendations for any specific individual or entity. For personalised investment decisions, individual investors are advised to consult their licensed financial professional advisor. The opinions expressed by the Manager are based on certain assumptions or prevailing market conditions, and they are subject to change without prior notice. This material is being distributed for informational purposes only and should not be regarded as investment advice or an endorsement of any particular security, strategy, or investment product. While the information provided herein may include data or opinions from sources believed to be reliable, its accuracy and completeness are not guaranteed. Reproduction of any part of this material in any form or reference to it in other publications is strictly prohibited without the express written permission from Halogen Capital Sdn Bhd. Halogen Capital Sdn Bhd and its employees assume no liability regarding the use of this material or its contents.