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Asian Bonds Decline Amid Inflation and Rate Concerns

Asian bonds retreated in February as investors digested the impact of stronger-than expected economic data on the future path of US Federal Reserve rate hikes.

SSGA Fixed Income Portfolio Strategists

March 2023 saw Asian bond markets give up most of the previous month’s gains, with the Markit iBoxx ABF Pan-Asia Index returning -4.56% on an unhedged basis in United States dollar (USD) terms and -0.77% on a USD hedged basis. A raft of surprisingly strong economic data, particularly in the US, began to fuel a more combative US Federal Reserve (Fed) tone, raising concerns that the central bank’s efforts at controlling inflation were moving at a slower-than-expected pace. Consequently, the market’s prediction about the peak level of interest rates increased by 50 basis points (bps) during the month, and the USD strengthened against most emerging- and developed-market currencies.

Country Local Currency Bond Return FX Return Total Return (in USD)
Korea -2.62% -6.91% -9.35%
Thailand -0.06% -7.32% -7.38%
Malaysia -0.17% -5.26% -5.42%
Singapore -2.04% -2.65% -4.64%
China 0.06% -2.76% -2.70%
Philippines -0.79% -1.31% -2.09%
Hong Kong -1.76% -0.12% -1.88%
Indonesia 0.17% -1.70% -1.54%

Growth Slowdown and Currency Weakness

In Korea (-9.35%), the central bank kept interest rates unchanged at 3.5% following its February 2023 policy meeting and cut this year's growth forecast from 1.7% to 1.6% year on year. These moves reflected slower growth in private consumption (2.7% to 2.3%) and weaker real export growth (0.7% to 0.5%). The Bank of Korea (BoK) has tried to keep pace with US-rate-hikes to prevent an excessive weakening of the Korean won against the USD and capital flight. However, the BoK’s progress has been hampered by less conducive economic conditions and expectations that the Fed would continue to raise rates. As a result, the exchange-rate gap versus the USD widened to a 22-year record of 1.25%.

Larger-Than-Expected Trade and Current Account Deficits

Thailand (-7.38%) reported a surprisingly large trade deficit of USD 2.7 billion in January 2023. And despite positive inflows from foreign tourists, the current account also registered a deficit of USD 2 billion – the most significant gap since August 2022. As a result, the Thai baht weakened significantly, and we saw outflows from Thai securities, which reached USD 1.1 billion in February 2023, the most significant monthly withdrawal in almost a year.

Softer Exports Could Delay Interest-Rate Hikes

Malaysia’s underperformance (-5.42%) was driven mainly by foreign-exchange (FX) weakness. Meanwhile, its trade surplus narrowed to MYR18.2 billion in January 2023 from MYR28.1 billion in December 2022, as exports – particularly those of tech products – fell in tandem with the global tech down-cycle. With exports slipping by 8.5% month on month in January 2023 – extending the 5.4% decline witnessed in December 2022 – investors now anticipate that the central bank will delay any further rate hikes.

Inflation Remains in Focus

In Singapore (-4.64%), local-currency bonds and FX retreated as a repricing of US rate-hike expectations eroded the market’s appetite for risk assets, sending investors back to the perceived safety of the USD. Lower-than-anticipated core and headline inflation (5.54% and 5.7%, respectively) failed to provide a source of comfort for market participants who expect the Monetary Authority of Singapore (MAS) to maintain a high degree of vigilance toward controlling price rises. Indeed, a 50 bp increase in the slope of the Singapore-dollar nominal effective exchange rate (S$NEER) policy band is now expected at the April meeting of the MAS.

Fed Rate Expectations Trigger a Decline in the Yuan

China (-2.7%) saw the yuan weaken against the USD, as investors believed the Fed would pursue higher-for-longer interest-rate hikes. This contrasts with the People’s Bank of China (PBoC), signaling stable policy moves as the economy rebounds. In other developments, there were no signs of a cooling in tensions between China and the US.

Rising Consumer Prices in the Philippines

In the Philippines (-2.09%), the Bangko Sentral ng Pilipinas (BSP) lifted its overnight borrowing rate by 50 bps to 6%, which was higher than the market had expected. The BSP also raised its 2023 inflation forecast by more than anticipated (4.5% to 6.1% year on year). The elevated forecast came as inflation rose in January 2023 due to increases in food prices that were underpinned by acute shortages of key items, transport fare hikes, and wage increases. The Philippine peso’s sell-off was less pronounced than that experienced by other emerging Asian currencies, as the BSP maintained its position as one of the most aggressive central banks in emerging Asia. Investors believe the BSP will be able to maintain its target of a 100 bp differential between Philippine interest rates and those of the Fed.

Rate Moves Dent the Appeal of Hong Kong Bonds

Hong Kong’s underperformance (-1.88%) was almost exclusively a result of weak local-currency bond returns triggered by a need for the Hong Kong Monetary Authority (HKMA) to raise interest rates in lockstep with a potentially more aggressive Fed. Price pressures have also started to pick up recently, with consumer inflation rising by a stronger-than-predicted 2.4% year on year in January 2023 (from 2% in December 2022). Even amid tight financial conditions with elevated interest rates, the reopening with mainland China and a return of tourists could boost underlying price pressures in the coming months.

Growth Expectations Rise in Indonesia

Indonesia (-1.54%) saw the FX element sell off at a relatively milder rate than other markets as its growth outlook improved. Bank Indonesia (BI) now expects 2023 growth to come in at the upper end of its 4.5-5.3% range. BI kept interest rates at 5.75% following its February 2023 policy meeting, which aligned with market predictions. It guided that rates were sufficiently high to keep core inflation (3.3%) within the 2-4% target range. Despite an increase in the market’s prediction about the peak level of Fed interest rates, BI remains confident that it has other tools, such as FX management and term-structure adjustments, to cushion the impact on the domestic economy and markets.

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