Since the market shock of March 2020, Asian local-currency bonds have had a good run. For instance, the Markit iBoxx ABF Pan-Asia Index, which tracks local currency government and quasi-government bonds in eight Asian markets, moved from a March 2020 low to a high in early January 2021 – a solid 15.9% upward move1. Although levels have dipped slightly since then, the index still ended January 2021 at an almost seven-year high.
The reasons for this minor retracement likely come down to global risk appetite. Asian local-currency bonds have indeed benefited from the recovery in sentiment. But further optimism, driven by the vaccine and new fiscal stimulus in the United States, may have pushed some investors further up the risk curve toward equities.
Despite this, we believe that the environment remains supportive of Asian fixed income. We see three broad factors contributing to this: credit fundamentals, accommodative monetary policy, and currency appreciation.
Asia has managed the pandemic better than its European or North American counterparts, albeit with market-specific variations2. On the economic side, although the latest gross domestic product (GDP) figures still predictably show a year-on-year decline, recovery momentum has picked up. But even then, there are outliers, such as China and Vietnam. The former has seen yearly GDP growth from the second quarter onward, while the latter never dipped into negative territory3, 4.
Of course, Asian economies are experiencing fiscal stress. But coming from a base of lower debt-to-GDP5 and higher domestic savings6 – plus opting for smaller stimulus measures – means that future fiscal deterioration will be more limited. For instance, the Institute of International Finance estimates that government debt across emerging Asia will reach 77% of GDP by 2025. While this is about double pre-pandemic levels, it still compares favourably to developed economies that are expected to surpass 125%7.
In tandem with Asia’s greater fiscal room is its lower reliance on central-bank largesse – both before and during the pandemic. Although interest rates in Asia have fallen across the board, the point here is that there was room for rate cuts in the first place. Debt monetisation has been happening in a few Asian economies like Indonesia, but these outliers are expressedly stated to be only temporary8. This contrasts with ongoing asset-purchase programmes by the European Central Bank and the US Federal Reserve (Fed)9.
As such, relative yields remain attractive – a big selling point given that the Fed is expected to begin raising rates in late 2023 or 202410, 11. A fact bolstered further by subdued inflation across the region that has boosted real yields12.
The Fed’s accommodative monetary policy has also flooded the market with liquidity, which is quickly finding its way to Asia in the hunt for higher yields. For example, Asian sales of dollar-denominated debt hit a record USD22.8 billion in the first week of January 2021, demonstrating strong demand and foreign investors’ increasingly higher allocations to the region’s debt13. In December 2020, the Fed also extended two liquidity programmes until September 2021, proving its commitment to keeping the liquidity spigot flowing14.
These last two factors are supportive of the broader Asian fixed income landscape. Within this universe, Asian local-currency bonds are also receiving a boost from the currency effect. Accommodative monetary policy has exerted downward pressure on the US dollar, with the Bloomberg JPMorgan Asia Dollar Index progressively increasing since March 2020 to reach three-year highs15. This currency appreciation has further added to Asian local-currency bond yields.
While these three broad factors augur well for Asian fixed income – especially in the local-currency space – investors should also keep a keen eye toward the risks. One is a sooner-than-expected rate hike by the Fed. This could result in a “taper tantrum” that causes the US dollar to appreciate, liquidity to tighten, and relative yields to decline.
Fortunately, all indications point toward that being at least a couple of years down the line with the Fed being cautious on its communique with the market to avoid rate hike expectations induced sell-off. The Fed is now under immense pressure to keep markets buoyant, making the probability of a sudden rate hike very low. By the time that occurs, however, Asia should have further improved its fiscal resilience. For instance, many countries have maintained their current account surpluses despite the pandemic, or even gone from deficits to surpluses – such as Indonesia16.
The possibility of a debt crisis, while low, is also ever-present. Still, any wave of defaults is likely to hit the corporate sector first, starting with the high-yield segment. Navigating the trade-off between risk and reward in Asian fixed income is thus critical. To find that delicate balance, focusing on sovereign bonds may be the best route forward.
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1 Bloomberg Finance L.P.
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The views expressed in this advertisement are the views of Kheng-Siang Ng through the period ended 31 January 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.