Asian Bond Markets Navigate Challenging Conditions in 2023

2023 was dominated by higher interest rates as central banks focused on dampening inflation, resulting in elevated Asian bond yields.

A significant headwind for Asian bond prices in 2023 has been the external impact of steadily increasing US bond yields coupled with a strong US dollar. US bond yields rose as the US Federal Reserve (Fed) lifted interest rates to bring down high inflation.

Asian central banks did not act uniformly to this external pressure. Policymakers in smaller markets had little choice but to follow the Fed’s lead and raise or maintain interest rates to bolster their respective exchange rates, which would otherwise have declined more rapidly. A sharply depreciating currency could trigger investor panic and see a rapid withdrawal of capital by foreign investors.

China’s Weaker-Than-Expected Recovery

Due to its size, economic power, and being at a later stage of its post-COVID economic recovery, China chose instead to reduce interest rates to stimulate its economy and assist sectors with large debts.

At the beginning of 2023, there were expectations of a solid economic recovery in China as the nation emerged from pandemic-related lockdowns. However, the rebound was less robust than many investors anticipated.

Issues connected to the high levels of debt held by some property developers in China had a negative impact on both investor and consumer sentiment.¹ Subsequent policy support for the property sector is slowly taking effect, but certain real estate developers have large debt loads that will probably need restructured. Most other Asian markets have not experienced the same level of distress in their property development sectors.²

Returning to China, the consumer demand outlook appears slightly more negative than most other Asian markets. This is partly due to property sector issues but also the impacts of relatively high youth unemployment and weaker-than-expected consumer confidence.³

The government has taken steps to support economic growth by increasing its budget deficit and is prepared to exceed its 3% limit on the deficit to GDP ratio.⁴ Despite these economic uncertainties, the International Monetary Fund (IMF), in its October 2023 World Economic Outlook report, projects that China’s economy is still on track to expand by around 5% in 2023. This growth rate is healthy by global standards.⁵

Central Bank Efforts to Reduce Inflation Drive Government Bond Yields Higher

Central banks around the globe have raised interest rates to dampen inflation. As a result, bond yields increased throughout much of 2023. Recently, though, we’ve seen some yields decline as investors predict that the Fed is approaching the end of its rate-hiking cycle.⁶ In Asian economies, inflation was driven more by higher energy prices than tight labour markets, which is occurring in the US. This battle against rising prices appears successful, with the IMF predicting that global inflation will fall to 6.9% in 2023 from a rate of 8.7% in 2022.⁷

As mentioned, the US dollar also rose in value against most other Asian currencies throughout 2023 as the Fed lifted interest rates and bond yields rose in tandem.⁸ When government bonds offer higher yields, it reduces the relative appeal of other investments, like equities, but it also directly impacts the financial positions of companies that now must pay more in interest for their loans or bond issues. This drag on company earnings helps reduce overall economic demand levels, placing downward pressure on prices and leading to lower inflation. This pressure is what central banks are hoping to achieve by lifting interest rates.

As we look to 2024, many Asian central banks will likely start cutting interest rates. The rate decisions of the Fed in the coming months will be the most significant factor shaping the future of borrowing costs in most Asian markets.

Energy Prices are a Variable Factor for Asia

With some exceptions, most Asian markets depend on energy imports, so they benefit economically from lower prices. Another negative is that strong energy prices feed directly into inflation, which pressures central banks into maintaining higher interest rates than would otherwise be necessary. According to the World Bank, crude oil prices should remain stable or even decline slightly in 2024.⁹ Despite this potentially beneficial backdrop, the geopolitical situation remains fragile, and as the situation between Israel and Gaza demonstrates, conflicts can erupt swiftly and with little warning.

The Outlook for Asian Bonds Hinges on Global Interest Rates

With the inflationary outlook steadily improving in most regions, we could expect to see interest rates potentially decline in certain markets. That will probably only occur once the Fed is satisfied that inflation is on an acceptable trajectory and unlikely to flare up again soon.

As such, Asian bond investors should view 2024 with cautious optimism while keeping a close eye on the Fed for signs that interest rates could start to decline.