Asian Bonds Enter 2025 on a Firm Footing

Lower interest rates, easing inflation, positive economic fundamentals, and a weakening dollar should support Asian local-currency bond markets in 2025.

In 2024, unexpectedly healthy economic data coupled with a delayed start to the rate-cutting cycle ensured that global fixed-income markets experienced a somewhat unsettled year. However, economic indicators have since softened, and inflation has eased, which means that central banks could explore further reductions in borrowing costs. The pace of these cuts may be more challenging to predict now that Donald Trump has assumed office, but the downward trend is apparent. Moreover, any lack of clarity might create tactical openings for investors to increase or adjust their duration exposure as the easing cycle unfolds.

This year will also be marked by geopolitical themes. The global economy might appear similar to one witnessed over the past few decades, but this view masks factors that threaten to break long-held economic and financial connections. For instance, the trade dynamics between the United States and China could deteriorate, and increased tariffs imposed by the US on goods from China suggest a rise in the value of the dollar and a decline in the renminbi. More broadly, some markets could become more competitive compared to China, while others may attract greater investment from Chinese firms seeking to re-route production to evade tariffs.

From a fiscal perspective, any increased government spending on capital projects is expected to be directed towards, for example, energy and industrial infrastructure. Since this expenditure boosts business expansion, it may lead to an increase in interest rates as growth projections become more optimistic.

Against this backdrop, there is undoubtedly value in Asian bond markets, but investors need to accept the potential for increased instability.

Demographic Trends May Anchor Sovereign Bond Yields

As central banks focus less on inflation and adjust interest rates to reflect domestic demand and global economic activity, we anticipate that government bonds in many markets will deliver appealing returns. Analysts currently predict that US borrowing costs could dip to around 3.75%, and when rate reductions occur, yield curves will decline, primarily driven by bonds with shorter maturities.

Long-term demographic trends also reinforce our optimistic view of bonds. Weak labour market dynamics and modest productivity increases could limit growth in many developed markets, consequently anchoring sovereign yields over the medium to long term.

Conversely, fiscal deficits and high debt levels pose a threat and signify the most apparent danger to our generally upbeat forecast.

Favourable Refinancing Presents Opportunities for the Asian High-Yield Market

As spreads have reached their narrowest point since 2007, the performance of high-yield debt will be influenced more by lower underlying yields rather than spread tightening.

Given worries about an impending maturity wall, many issuers have capitalised on these declining yields and narrower spreads to refinance – a trend primarily seen in the US-dollar market. Closer to home, favourable refinancing circumstances could also create the same opportunities for Asian issuers.

Limited Room for Spread Compression Among Investment-Grade Bonds

While credit conditions remain robust, we will likely see a decline in balance sheet stability and the interest coverage ratio as the credit cycle advances. Even though leverage among US non-financial firms has fallen from the highest point (seen during the pandemic), it has started to increase. The profit margins of these companies have also touched record levels.

However, if this pattern eases, it's improbable that the interest coverage ratio will improve and could deteriorate. More generally, the potential for further spread compression appears limited, given that investment-grade spreads are already close to all-time lows.

Positive Fundamentals Should Support Emerging-Market Debt

Many credit events have been anticipated across the emerging-market (EM) universe, and a positive US Treasury outlook suggests that EM debt could still present investment opportunities. Furthermore, lower US interest rates will likely dent the dollar's value, enhancing EM investments' appeal.

Yet, we cannot expect all markets to provide the same degree of policy support in 2025. For instance, China can increase local demand, but the success of both current and future initiatives is not clearly defined.

The shifting policy direction of the Trump administration will impact US Treasury yields and the US dollar, consequently affecting various segments of the EM debt segment. Protectionist US trade policies could have significant consequences for individual markets depending on how targeted they are.

Overall, we believe that Asia will continue to enjoy solid growth, especially as inflation has started to ease. Furthermore, its local-currency bond markets should expand in 2025, bolstered by a healthier corporate climate and increased regional fund flows.