Malaysian bonds have seen a net foreign bond outflow of US$263mil in the first two months of the year. — Reuters
Singapore: Foreign investors are turning cautious on emerging Asian bonds as the rising cost of hedging eats into returns.
Their waning global interest in the region’s local-currency bonds is evident in markets like South Korea and Malaysia where inflows have either reversed or slowed.
That comes as a measure of local currency forward points in seven emerging Asian currencies rises on average 0.6 standard deviations above the twelve-month average, in a sign that it has become more expensive for investors to swap US dollars for the local currency.
Forward points are expected to rise further, with the US Federal Reserve (Fed) seen cutting interest rates this year, further eroding returns on US dollar-hedged investments.
Asia forex forward points have edged higher since November due to lower volatility as well as reduced depreciation concerns for Asian currencies, said Alvin Tan, head of Asia forex strategy at RBC Capital Markets in Singapore.
Nonetheless, it’s important to note that the forward points still remain negative in absolute terms, he added.
Malaysian bonds have seen a net foreign bond outflow of US$263mil in the first two months of the year, according to most updated data, after a US$3.8bil inflow in 2023.
Global inflows into Sourth Korean bonds have fallen to US$6.4bil so far this year, after a US$60bil inflow in 2023.
Investors will also need to be mindful of currency policies in the region. Yuan forward points surged 94 points last Friday after the People’s Bank of China’s weaker currency fixing fanned speculation it was loosening its tight grip on the yuan.
That’s before forward points pared the rise as the central bank reaffirmed its currency support with stronger-than-expected reference rates this week.
Local forward points turned favourable for global investors in 2022 when the Fed hiked rates much more aggressively than emerging Asian nations, resulting in a wide rate gap between the two.
That had made it attractive for foreign investors to borrow Asian currencies in exchange for the greenback.
Global funds are expected to lose that advantage with the Fed forecast to trim rates this year.
For example, Malaysia’s three-year bonds offer a return of around 5.70% now versus an average of 6.2% in October to US dollar-based funds that hedge against the ringgit’s moves using three-month currency forwards.
Moreover, the US rate premium over emerging Asia economies will narrow if the Fed moves sooner than regional policy makers on rate cuts.
Beginning in June, the Fed is expected to cut rates by a cumulative 75 basis points this year, while central banks in South Korea, Malaysia and Singapore will not be as dovish, RBC’s Tan added. — Bloomberg
