Malaysia Bond Market Outlook 2H26: Between a Barrel and a Ballot Box

Highlight

• Inflation contained despite oil shock: Fuel subsidies, cash assistance, and SME financing support are expected to cushion pressures, keeping inflation within BNM’s 1.5–2.5% target range and largely supply-driven rather than demand-driven.

• Moderate GDP Growth: Growth remains supported by strong private consumption and a healthy labour market (3% unemployment), but softer household spending momentum and weaker manufacturing PMI suggest a gradual slowdown into 2H26.

• OPR held at 2.75% in 2026: Despite cost pressures, resilient domestic demand and supply-side inflation dynamics imply no rate cut or hike under the base case.

• Fiscal deficit risks remain manageable: Higher fuel subsidies may push the deficit slightly above the 3.5% of GDP target if oil prices stay elevated, but this is expected to be partly offset by BUDI Madani savings, higher Petronas dividends, and stronger petroleum-related revenues.

• MGS yields to trend slightly higher: Election-related uncertainty and elevated US Treasury yields are likely to exert mild upward pressure on MGS yields in 2H26.

• Recommendation: Shift preference from 5-7 year to medium-term 3–5 years attractive; A-rated corporate bonds preferred for wider spreads.

In our 2026 Malaysia Bond Market Outlook published earlier this year, we expected inflation to remain stable and manageable, with Malaysian Government Securities (MGS) yields broadly stable, while projecting a 25bps reduction in the Overnight Policy Rate (OPR) as our base case for 2026. However, following several key developments during 1H2026—including the escalation of Middle East tensions and brent oil prices surpassing USD100 per barrel—we are reassessing our outlook for the second half of the year.

Malaysia Bond Market Outlook 2026: Stability Amid Global Uncertainty | FSMOne

Inflation Expected to Remain Broadly Contained

Malaysia Headline inflation rose from 1.7% YoY in March to 1.9% YoY in April, initially driven by a 4.1% spike in transportation costs from higher global oil prices. The rate reached 2.0% in May (chart 1), reflecting a gradual, modest pass-through of these upstream energy pressures into broader consumer goods.

Although rising energy cost pass-through may raise inflation risk, we believe the impact should be partly cushioned by the policy support already in place. Continued fuel subsidies for eligible groups, cash assistance programmes such as Sumbangan Tunai Rahmah (STR) and Sumbangan Asas Rahmah (SARA), as well as SME financing support, should help contain the pass-through to households and businesses.

We expect headline inflation to remain above 2% in 2026, within Bank Negara Malaysia (BNM)’s forecast range of 1.5% to 2.5%, while core inflation should remain relatively contained, implying that the inflation pressure is largely driven by higher energy and input costs rather than stronger demand conditions. As such, we do not expect inflationary pressure to broaden into demand-driven inflation or warrant a monetary policy response at this stage.

Chart 1: Elevated oil prices exert higher inflation pressures

Malaysia Growth Remains Resilient but Moderation Expected in 2H26

Malaysia’s economic performance remained resilient in 1Q26, with GDP expanding by 5.4% YoY, topping market expectations despite moderating from the strong 6.2% growth recorded in 4Q25 (chart 2). This was underpinned by expansion in the manufacturing, services and construction while gains were partially offset by a contraction in mining and quarrying.

On the demand side, domestic activity remained the key anchor, with private consumption rising 4.7% YoY, supported by healthy labour market conditions as reflecting a low unemployment rate of 3.0% as of April 2026 (Chart 3), alongside continued cash assistance and firmer household income. That said, softer leading indicators, including manufacturing PMI data, suggest a slower momentum into 2H26. Encouragingly, investment activity should remain supported by ongoing infrastructure projects, data centre development and private-sector capex.

Overall, while we remain constructive on Malaysia’s domestic growth outlook, we expect full-year GDP growth to come in at the lower end of our 4.0% to 4.5% forecast range, driven by rising cost pressure from elevated oil prices and softer consumption momentum.

Chart 2: Malaysia GDP growth

Chart 3: Malaysia Unemployment Rate

OPR to remain steady at 2.75% throughout 2026

In terms of monetary policy, we expect BNM to keep the Overnight Policy Rate (OPR) at the current accommodative level of 2.75% throughout 2026. While inflation is expected to trend higher, we believe the pressure remains manageable and is unlikely to warrant a policy response under our base case. With domestic demand moderating but remaining resilient, labour market conditions healthy and inflation largely supply-driven as highlighted above, there is no compelling case for either a rate cut or a rate hike. That said, we do not rule out tighter monetary policy if cost pressures become more persistent, although this is not our base case.

Chart 4: Malaysia Overnight Policy Rate (OPR)

Higher Oil Prices Pose Fiscal Deficit Risks, but Medium-Term Consolidation Remains Intact

Previously, diesel is sold at a subsidised price of RM2.15 per litre in Sabah and Sarawak, while consumers in Peninsular Malaysia pay the market-linked retail price of RM4.37 per litre. Starting 1 July 2026, the subsidised diesel price will be standardised nationwide at RM2.10 per litre, allowing eligible Malaysians in Peninsular Malaysia to enjoy subsidised diesel while restricting access for non-citizens.

Under the new framework, the diesel subsidy quota will be integrated into the existing BUDI Madani scheme, with eligible recipients receiving a combined monthly allocation of 200 litres covering both subsidised RON95 petrol and diesel, instead of separate quotas for each fuel type. The integrated approach is expected to improve subsidy targeting, reduce leakages arising from price differentials, and provide beneficiaries with greater flexibility in managing their monthly fuel consumption (Figure 1). The government estimates that the enhanced BUDI Madani programme will generate annual fiscal savings of approximately RM2 billion.

Figure 1: Progressive Fuel Entitlements Under the BUDI Madani Diesel Programme

Under Budget 2026, the government initially allocated RM15 billion for fuel subsidies. However, the sharp increase in global energy prices has significantly raised subsidy costs. According to the Ministry of Finance (MOF), fuel subsidy expenditure reached an estimated RM11.2 billion during the first four months of 2026. Based on current oil price assumptions, we estimate total fuel subsidy expenditure could increase to approximately RM40 billion for the full year should elevated global oil prices persist.

While elevated global oil prices have increased fuel subsidy costs, they have also strengthened Malaysia's oil and gas (O&G) trade balance. As shown in Figure 2, the overall O&G trade surplus improved to around 2.0% of GDP in 1Q26, driven primarily by stronger natural gas exports despite Malaysia remaining a net importer of crude petroleum (Chart 5). The stronger O&G trade surplus, together with higher petroleum income tax collections, the potential for larger special dividend contributions from Petronas driven by higher oil price, expenditure rationalisation and cost-cutting initiatives, as well as fiscal savings from the enhanced BUDI Madani programme, should help cushion the fiscal impact of higher fuel subsidy expenditure.

As a result, we expect the fiscal deficit to come in slightly above the government's 2026 target of 3.5% of GDP, at approximately 3.6% of GDP, if elevated oil prices persist. However, any deviation is likely to be limited given ongoing fiscal consolidation efforts. Should global oil prices moderate in the second half of the year, the government would have a higher probability of achieving its fiscal deficit target of 3.5% of GDP.

Importantly, the government's fiscal track record provides confidence in its consolidation efforts. In 2024, the fiscal deficit narrowed to 4.1% of GDP, outperforming the initial target of 4.3%. Similarly, in 2025, the fiscal deficit came in at 3.7% of GDP, slightly better than the 3.8% target (Table 1). This consistent overachievement reflects prudent fiscal management and strengthens our confidence that the government remains committed to achieving its medium-term fiscal consolidation target of 3.0% of GDP by 2028, even amid temporary pressures from higher energy prices.

Chart 5: Malaysia's O&G Trade Surplus Strengthened on Robust LNG Exports

Table 1: Malaysia Fiscal Deficit Target vs Actual Outcome

Year	Fiscal Deficit Target (% GDP)	Actual Fiscal Deficit (% GDP)
2024	4.3%	4.1%
2025	3.8%	3.7%
2026	3.5%	3.6%*
*iFAST Forecast Source: Department of Statistics Malaysia (DOSM), iFAST Compilation. Data as of 13 February 2026

MGS Yields to Trend Slightly Higher in 2026 Amid Election Risk Premium and Elevated UST Yields

Prime Minister Anwar Ibrahim’s comment that a snap election could be considered if cracks continue to form within the unity government, followed by the resignations of senior PKR leaders and the upcoming state elections, has added fresh uncertainty to the domestic political landscape. Election-related uncertainty could lead to a modest increase in Malaysia Government Securities (MGS) yields as investors demand a higher risk premium and adopt more defensive positioning.

During GE14 (2018), the 10-year MGS yield increased from 3.95% at the point of Parliament dissolution to 4.15% on polling day, and further to 4.21% one week after polling. It subsequently peaked at 4.30% on 25 May (Table 2). This upward movement reflects heightened election uncertainty and market concerns following the unexpected change in government. As policy direction became clearer under the new administration, uncertainty gradually eased and yields stabilised thereafter.

During GE15 (2022), the 10-year MGS yield was broadly stable at 4.38% between Parliament dissolution and polling day, before easing to 4.11% one week after the election. However, the 10-year MGS yield later rose to a cycle peak of 4.56% on 21 October (Table 2). This increase was not primarily driven by domestic political developments, but rather by aggressive U.S. Federal Reserve tightening, with the Fed funds rate upper bound increasing by 75 bps and the 10-year U.S. Treasury yield exceeding 4%. In contrast, Malaysia’s Overnight Policy Rate (OPR) increased by only 25 bps over the same period, indicating a more gradual domestic policy response. This suggests that global yield pressures, particularly movements in the UST yield curve, exerted a stronger spillover impact on MGS yields than election-related risks.

Looking ahead, U.S. inflation is expected to remain higher for longer, driven by sticky inflation. We are leaning toward further Fed rate hikes, although the policy outlook remains data dependent, with rate cuts unlikely in 2H26. This is expected to keep U.S. Treasury (UST) yields elevated, exerting spillover pressure on MGS yields, while domestic election risk could contribute to upward pressure and volatility. Overall, we expect MGS yields to trend slightly higher in 2H26.

Table 2: 10Y MGS and UST Yield Movements Around Malaysian General Elections (GE14 & GE15)

General Election (GE)	Event	10Y MGS	10Y UST	Overnight Policy Rate	Fed Fund Rate (Upper Bound)
GE14	Parliament Dissolution (6 Apr 2018)	3.95%	2.77%	3.25%	1.75%
	Polling Day (9 May 2018) Date at 14 May 2018*	4.15%	3.00%	3.25%	1.75%
	After 1 week Polling Day (17 May 2018)	4.21%	3.11%	3.25%	1.75%
	Peak MGS Yield (25 May 2018)	4.30%	2.93%	3.25%	1.75%
GE15	Parliament Dissolution (10 Oct 2022) Date at 7 Oct 2022*	4.38%	3.88%	2.50%	3.25%
	Polling Day (19 Nov 2022) Data at 21 Nov 2022*	4.38%	3.83%	2.75%	4.00%
	After 1 week Polling Day (29 Nov 2022)	4.11%	3.74%	2.75%	4.00%
	Peak MGS Yield (21 October 2022)	4.56%	4.22%	2.50%	3.25%
*Market data are based on the nearest available trading day when the event occurred on a non-trading day. Source: Bloomberg Finance L.P, iFAST Compilations. Data as of 31 December 2022

Looking ahead, we expect MGS yields to remain slightly elevated in 2H26, although further upward pressure is likely to be gradual. Against this backdrop, we shift our preference from the 5–7-year segment to the medium-term (3–5 year) segment of the curve. This segment offers an attractive balance between yield and interest rate risk, allowing investors to capture reasonable carry while maintaining lower duration risk compared with longer-dated bonds.

Chart 6: MGS Yield Curve by Tenor

Tightening credit spread; Prefer A-rated bonds given the wider spread but selectivity required

The tightening credit spread makes us to continue favour the A-rated bonds, given their relatively wider spread against MGS (Chart 7). Among all credit ratings, BBB-grade bonds exhibit the widest spread. While higher yield bonds are generally associated with higher risk, this does not necessarily imply a higher likelihood of default. Depending on investor’s risk appetite, if high-yielder bonds sufficiently compensate for the additional risk, they may still be worth considering on a selective basis.

All in One

Overall, Malaysia’s macroeconomic outlook for 2H26 remains broadly stable, supported by resilient domestic demand, a healthy labour market, and prudent fiscal management, even as elevated global oil prices introduce modest upside risks to inflation and the fiscal deficit. The government’s strong track record of fiscal overachievement continues to support confidence in its medium-term consolidation path toward a 3.0% of GDP deficit by 2028.

With core inflation contained and price pressures largely supply-driven rather than demand-led, Bank Negara Malaysia (BNM) is expected to keep the Overnight Policy Rate (OPR) unchanged at 2.75% for the year.

On the bond market front, MGS yields are likely to trend slightly higher in 2026, driven by elevated US Treasury yields amid a higher-for-longer Fed policy stance, alongside a modest domestic election risk premium.

Against this backdrop, we favour a defensive positioning, with preference for the 3–5-year segment of the MGS curve and A-rated corporate credit, offering an attractive balance of yield and risk for investors navigating the year ahead.

Bond Recommendation

We have compiled a recommended list of government bonds of both MGS and MGII, as shown in Table 2. MGS are conventional government bonds, featuring fixed coupons (interest), with the coupon paid semi-annually and maturities ranging from 3 to 5 years. MGII, on the other hand, are the equivalent of MGS but based on Islamic principles.

Together, MGS and MGII are known as Malaysian Government Bonds. Investing in these instruments essentially means lending to the government in exchange for fixed coupon payments until maturity, making them among the safest investment options in the Malaysian market, as they are backed by the government.

In addition, we have compiled a list of A-rated corporate bonds in Table 3 below, which are subject to market conditions and liquidity.

Table 2: MGS and MGII Bond

Issuer	Bond	Years to Maturity	Yield to Maturity	Min / Sub investment
Malaysian Government Securities (MGS)	MGS 3.885% 15Aug2029 Govt (MYR)	3Y1M	3.17%	MYR 10,000/10,000
	MGS 4.498% 15Apr2030 Govt (MYR)	3Y9M	3.28%	MYR 10,000/10,000
	MGS 4.232% 30Jun2031 Govt (MYR)	4Y11M	3.33%	MYR 10,000/10,000
Malaysia Government Investment Issue	MGII 4.130% 09Jul2029 Govt (MYR)	3Y	3.17%	MYR 10,000/10,000
	MGII 4.245% 30Sep2030 Govt (MYR)	4Y2M	3.35%	MYR 1,000/1,000
	MGII 3.804% 08Oct2031 Govt (MYR)	5Y3M	3.36%	MYR 10,000/1,000
Source: FSMONE, iFAST Compilations. Data as of 7 July 2026

Table 3: A-rated Bonds

Issuer	Bond	Years to Maturity/Years to next call	Yield to Maturity/Yield to Next Call	Min / Sub investment
JB Cocoa Sdn Bhd	JBCOCO 5.800% 12Nov2027 Corp (MYR)	1Y 4M/-	4.95%/-	MYR 5,000/5,000
	JBCOCO 5.950% 13Nov2029 Corp (MYR)	3Y 4M/-	5.29%/-	MYR 5,000/5,000
Yinson Holdings Berhad	YNSMK 5.000% 12Dec2030 Corp (MYR)	4Y 4M/-	4.65%	MYR 250,000/250,000
	YNSMK 7.500% Perpetual Corp (MYR) - Series 2	-/ 1Y 5M	-/4.79%	MYR 250,000/250,000
	YNSMK 7.500% Perpetual Corp (MYR)	-/2Y 8M	-/5.15%	MYR 250,000/250,000
Tropicana Corporation Berhad	DJCMK 6.250% 13Nov2028 Corp (MYR)	2Y 4M	4.95%/-	MYR 5,000/5,000
	DJCMK 6.100% 31Mar2031 Corp (MYR)	4Y 8M	5.50%/-	MYR 5,000/5,000
	DJCMK Jun2031 Corp (MYR)	5Y	6.00%/-	MYR 5,000/5,000
Source: FSMONE, iFAST Compilations. Data as of 7 July 2026