(May 25): A stuttering rally in Malaysian government bonds may run into another roadblock as a heatwave sweeping across Southeast Asia threatens to drive up inflation.

Benchmark yields are likely to face further upward pressure if faster price gains prompt Bank Negara Malaysia to tighten policy again. Turbulence in Treasuries fuelled by the prospect of a US default may also stoke volatility in the near term.

Inflation risks “may be coaxing a few to punt that BNM could hike again”, said Philip McNicholas, Asia sovereign strategist at Robeco Group in Singapore. If dollar strength resumes, another hike is possible as “recent GDP and BoP data signalled Malaysia’s dissaving trend persists, so the only way to shore up the FX and adjust saving behaviour would be a hike”.

The odds are stacked against ringgit bonds after the central bank warned that inflation may flare up again, with commodity prices and an impending reduction in domestic subsidies among the key drivers. Global funds halted a five-month buying spree in Malaysian sovereign debt in April amid uncertainty over the US interest-rate outlook.

Investors have turned cautious about ringgit bonds after pushing 10-year yields to the lowest since March 2022 earlier this month on bets that borrowing costs may have peaked. The shift in sentiment comes as authorities warn that the ongoing hot weather may hit the nation’s food supplies.

Malaysia’s food inflation “certainly” faces an upside risk from the scorching temperatures that are expected to last until August, according to Moody’s Investors Service, which thinks that another rate hike is possible.

Economists expect a report due Friday to show that the nation’s annual consumer-price growth eased to 3.3% in April from 3.4% in March.

Bank Negara Malaysia has delivered five rate hikes in the past year, with the latest increase taking place on May 3 as policy makers sought to ward off the risk of financial imbalances.

Still, not everyone thinks rates are headed higher. Australia & New Zealand Banking Group Ltd expects authorities to deploy fiscal and administrative measures instead to tackle any increase in prices.

“The ringgit bond market has one of the most constructive local supply-demand dynamics, which we expect to continue anchoring yields amidst a volatile global rates backdrop,” said Jennifer Kusuma, senior Asia rates strategist at ANZ. The bank is “mildly constructive on the shorter-dated segment up to the 5-year, where we see the balance of risks around yields as tilted to the downside” as the central bank stands pat for the rest of the year.

For its part, Maybank Securities Pte thinks that the gains in Malaysian bonds may have run their course for now, although 10-year yields are likely to drop to 3.5% by year-end from around 3.8% now.

“It requires some external drivers e.g. a stabilisation in US Treasuries for investors to regain confidence and resume the rally,” said Winson Phoon, head of fixed-income research at Maybank Securities. “I reckon a good buy on dip demand to cap or slow yield increases, but a rally would require stronger catalysts.”