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Asian Bonds Edge Higher as Interest Rate Hikes Loom

Asian bond markets edged up in October 2021, but investors continue to eye higher interest rates on the horizon as inflation and growth levels increase.

SSGA Fixed Income Portfolio Strategists

Asian bond markets delivered modestly positive returns in October 2021, with the Markit iBoxx ABF Pan-Asia Index rising by +0.12% on an unhedged basis in United States dollar (USD) terms. However, the index was down by -1.20% on a USD hedged basis. Even though most Asian central banks do not plan to raise interest rates quite yet – Latin America, for example, is leading the way here – investors continue to reassess the levels they believe interest rates will reach as inflation rises and growth picks up globally.

Market Local-Currency Return Foreign-Exchange (FX) Return Return (in USD)
Indonesia 0.79% 1.09% 1.88%
Thailand -1.07% 2.27% 1.17%
China -0.34% 1.17% 0.83%
Malaysia -0.87% 1.07% 0.19%
Philippines -1.26% 1.19% -0.09%
Singapore -1.81% 1.26% -0.57%
Hong Kong -0.96% 0.15% -0.80%
Korea -2.51% 1.32% -1.22%

Supportive policies and low inflation
Indonesia was the region’s best performer, with the FX element strengthening and local bonds rallying. Bank Indonesia (BI) left its interest rate unchanged at 3.5% and repeated that it would continue to follow a pro-growth agenda. It also downplayed the potential impact of the US Federal Reserve’s decision to reduce the scale of its monthly economic support program. Furthermore, consumer inflation in Indonesia remains low, with year-on-year increases of 1.65% in October 2021 and 1.6% in September 2021 – this was below BI’s 2–4% target range.

Currency recovery but energy prices cause concern
Thailand had a positive month, as the Thai baht (THB) partially recovered from weakness in September 2021. That said, challenges remain – Thailand is a net oil importer, so the recent rise in energy prices is expected to place pressure on the current account deficit (the difference between the value of imports and exports), which is wider than the central bank’s estimate of USD 15.3 billion for 2021. Concerns about higher government debt have also led to some weakness after Thailand increased the debt ceiling from 60% to 70% of its Gross Domestic Product (GDP). This followed fresh borrowing of THB 1.1 trillion to fund the gap between overall income and expenditure and pay for COVID relief packages. The Bank of Thailand has limited tools at its disposal to provide additional assistance and is expected to maintain interest rates at an all-time low of 0.5% until the economy shows signs of a strong recovery.

A suite of supportive factors in China
China performed reasonably well in October 2021, with most support coming from the FX component. Even though domestic growth has weakened in recent months, a combination of factors has ensured that China’s currency, the renminbi, has remained resilient. These include supportive inflows of capital following the inclusion of China’s bonds in global fixed-income indices, a belief that the People’s Bank of China will contain any fallout from property developer Evergrande’s debt crisis, and expectations that a broad reduction in the amount banks need to hold in reserve is no longer needed. In addition, China has a supportive current-account surplus, which means the value of its exports is higher than the amount it imports.

Manufacturing improvements and COVID containment
Malaysia was mostly flat, rising by 0.19%, as the FX segment recovered from last month’s sell off. Malaysia’s economy has been gradually opening, and COVID-19 infections have fallen as vaccination rates improve. The trade surplus also grew wider, standing at 26.1 billion ringgits in September 2021, up from 21.4 billion ringgits in August 2021. Elsewhere, manufacturing data for October 2021 improved following four consecutive months of decline. Investors expect Malaysia’s central bank to leave interest rates unchanged at 1.75% throughout the remainder of 2021.

Signs of recovery amid ongoing central bank action
Philippines dipped by -0.09%, as local bonds and FX moved in opposite directions. Even though consumer inflation was slightly lower in September 2021, it remains above Bangko Sentral ng Pilipinas’ (BSP) target band of 2–4%. The BSP has reiterated that it will continue to support the economy but is mindful of triggering a rise in inflation. Growth in the Philippines has also been recovering in tandem with a reduction in COVID infections, with October’s manufacturing output reaching a seven-month high.

Currency relaxation amid rising inflation
Singapore was down by -0.57% in USD terms, with local bonds a primary driver of the month’s weakness. The Monetary Authority of Singapore’s (MAS) measure of consumer inflation was 1.2% (year on year) in September 2021 from 1.1% in August 2021– this was higher than expected. The MAS also allowed the Singapore dollar to appreciate slightly, a move that investors had not anticipated.

Local businesses feel the pinch
Hong Kong returned -0.80%, with most of the decline coming from local rates (-0.96%) – this was in line with the global sell off in bonds. A survey of private-sector activity fell to a six-month low in October 2021, as the trade-reliant economy saw demand from mainland China soften. GDP growth was at 5.4% in the third quarter of 2021 (compared to the same period last year), which was lower than market analysts had predicted and down from 7.6% in the second quarter of the year.

Price rises could see a near-term interest-rate rise
Korea dipped by -1.22%, with Korean won strength insufficient to offset losses from local bonds. Inflation in October 2021 came in at 3.2% (year on year) – an almost ten-year high. When more heavily fluctuating elements were excluded from the number, ‘core’ inflation was still strong at 2.8%. Both these numbers were above the Bank of Korea’s 2% target. This broadening of price pressures has led markets to expect an interest rate rise towards the end of November 2021.