The first half of 2023 was dominated by US interest rate moves and China’s reopening. What could the next six months hold for Asian local-currency bonds?
Inflation in the US has started to fall as the impact of higher interest rates becomes apparent. This is welcome news for investors as it reduces the pressure on the US Federal Reserve (Fed) to continue raising interest rates. In May 2023, the US consumer price index (CPI) declined to its lowest level since March 2021.1 However, this doesn’t necessarily mean that borrowing costs have peaked, as most Fed officials expect further rate hikes to be required.2
From an Asian perspective, inflation is also moderating. However, this is from generally lower levels than in Western economies.3 As such, central banks across the region may have a greater ability to pause interest rate hikes or even reduce borrowing costs.4 So, while uncertainty remains high, the outlook for easier - or less hawkish – monetary policy settings in much of Asia is more positive than at the outset of 2023. Markets in Asia that experience static or even declining interest rates coupled with steady economic growth will create a generally favourable backdrop for local-currency bonds to perform well.
The International Monetary Fund (IMF) offers caution and explains that increased corporate borrowing in Asia could mean highly leveraged firms are exposed to tighter monetary policy. Even with economic growth, interest rate payments can exceed borrowing costs.5 Central banks in Asia will have to consider this factor and balance it carefully with the need to counteract inflationary pressures.
Asian currency performance was mixed in the first six months of 2023. The Japanese yen, Malaysian ringgit and Chinese renminbi fell in value against the US dollar.6 In contrast, the Indonesian rupiah has appreciated modestly, and the Thai baht and Philippines peso have remained almost unchanged. When the Fed signals that it is finished raising interest rates and is confident inflation has been controlled, it could lead to a decline in the US dollar, boosting the value of local-currency bonds in markets that see their currencies appreciate.7
While China remains the major manufacturing exporter in Asia, there has been a recent shift in the operational backdrop as businesses look to diversify their operations. This was partly triggered by the challenges faced by supply chains amid China’s lengthy lockdowns. And for some companies, like Taiwanese chip producers,8 increasing trade restrictions between China and the US are helping drive this shift. Also, labour costs in China are climbing, providing an economic reason for businesses to shift some production to less expensive markets.9
Most Asian markets suffered from a decline in their foreign currency reserves during the pandemic, but in recent months most have remained steady, and some, like Singapore, have seen a strong increase.10 Investors and rating agencies often view these reserves as an indicator of risk, with higher values viewed positively.11
The Asian Development Bank has noted that in many Asian markets, fiscal balances are improving as economic growth boosts tax receipts. At the same time, the winding back of emergency COVID measures and price controls mean government spending is now lower.12 Generally, a smaller budget deficit, or one that is not rapidly increasing, will also boost bond investors’ confidence.
There is also a positive outlook for growth in the issuance of green or sustainable bonds across Asian markets. The ratings agency, S&P Global, expects ethical bond issuance in Asia-Pacific to be US$240 billion in 2023, an increase of 20% compared to 2022.13 The picture across the region is currently divided, with higher issuance in China and Korea compared to Indonesia and Malaysia, but all markets should see some growth.
In the second half of 2023, there is a moderate risk that the Fed will increase interest rates further in its goal of taming inflation. This could trigger a global economic slowdown, which Asian markets would not entirely escape. Despite this risk, the outlook remains positive, with many indicators used by bond investors moving in the right direction.
The resilience of most Asian markets when managing the economic dislocation triggered by the pandemic demonstrates a growing financial and regulatory maturity. This prudent economic approach is helping underpin confidence in the region’s local-currency bonds.
3. https://www.oecd.org/dev/asia-pacific/economic-outlook/Overview-Economic-Outlook-Southeast-Asia-China-India.pdf (page 14)
12. https://www.adb.org/sites/default/files/publication/863591/asian-development-outlook-april-2023.pdf (page 12)
13. https://www.spglobal.com/_assets/documents/ratings/research/101572592.pdf (pages 2 and 6)
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