(Bloomberg) -- The near-term prospects appear bleak for Malaysian sovereign bonds as a weakening currency and dwindling hedged returns damp demand.

Hedged returns from Malaysian government debt have declined as rising currency forward points make it less attractive for investors to swap dollars for ringgit. For unhedged investors, the ringgit’s tumble to a 26-year low against the dollar adds to the case to avoid plowing money into sovereign securities.

To make matters worse, traders see minimal downside for bond yields after Bank Negara Malaysia signaled last month that it’s unlikely to ease policy as economic growth will probably improve in 2024. 

“We expect the central bank to hold the policy rate at 3.00% throughout 2024,” said Winson Phoon, head of fixed-income research at Maybank Securities Pte in Singapore. Benchmark 10-year Malaysian yields are likely to track a decline in their Treasury counterparts in the first half but headwinds are growing due to the US economy’s unexpected resilience, he said.

The following three charts illustrate the challenges confronting Malaysia’s bonds. 

1. Bills Foreign Flow

Global funds sold 2.5 billion ringgit ($522 million) of Malaysian bills in January, the largest outflow since September. Rising odds for a Federal Reserve interest-rate cut this year have led to increasing ringgit hedging costs for dollar-based investors.

This comes as asset swaps have become less appealing due to rising dollar-ringgit basis, hurting foreign demand for short-term local paper, according to a note from OCBC Bank Singapore last week. 

The substantial foreign outflows from shorter-term securities tend to weigh more on the ringgit than on the Malaysian bond curve, according to a note from Maybank Securities on Feb. 9. 

2. Hedged Pick-Up

Dollar-ringgit forward points have risen, averaging around 184 basis points in February, the highest on a monthly basis since March last year, according to calculations by Bloomberg. Climbing forward levels make it less attractive for a dollar-based investor to borrow ringgit in exchange for the US currency. 

3. Less Dovish

Traders remain hawkish over rate expectations from Bank Negara Malaysia, with ringgit swaps pricing very little change in rate moves over the next 12 months, as investors await the release of January inflation data on Friday. In comparison, traders see over 50 basis points of cuts in Thailand, while in South Korea, just over a quarter-point rate cut has been factored in. 

(Updates to add inflation data forecast in final paragraph)

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