Asia Pacific Head of Fixed Income, Head of SSGA Singapore
In addition to the tiger, 2022 could also be the year of the hawk. The US Federal Reserve (Fed) has signalled that it will raise rates at its March policy meeting1, with some analysts even predicting a 50-basis point hike – double what the broader market expects2. Indeed, consensus points to three increases overall in 2022, totalling 0.75—1.00%3.
The Fed isn’t alone. Many central banks across the developing world, ranging from Brazil4 to Russia5, are already ahead of the tightening curve. Meanwhile, the Bank of England has already raised rates twice6, and even the forever dovish European Central Bank is expected to hike later in the year7.
Asia’s Mixed Policy Responses
While other parts of the world have pivoted toward hawkishness, the response in Asia has been more varied. Markets like South Korea8, Indonesia9, and Singapore10 have all tightened their monetary belts in moves that often surprised investors. Yet, others, like Malaysia11, the Philippines12, and Thailand13, have opted to put any increases on hold for the time being.
Then there’s China, which has moved in the opposite direction and started to loosen monetary policy14. Its direction was firmly cemented in January 2022 when it lowered short-term, medium-term, and mortgage-lending benchmark rates, while signalling similar moves to come15.
A Correspondingly Mixed Effect on Asian Bonds
For local-currency sovereign issues, yields have increased (except for China and Vietnam)16. However, corporate bond yields have dropped17, despite the tightening environment. In general, rate-hiking cycles benefit corporate bonds, as spreads tend to narrow, partially absorbing the impact of rate increases.
The question is this: given the upward pressure on Asian government bonds, should investors trim their allocations to this asset class? After all, the trend indicates that the upward pressure on yields should only increase.
The answer: not necessarily. Here are three reasons why.
Consecutive Rate Hikes by the Fed are Far from Certain
While the expectation is for the Fed to raise rates several times this year, this is by no means a guaranteed outcome. Fed officials have strongly expressed their intention to keep their options open after the likely hike in March 202218.
This position makes sense. The Omicron variant is still spreading through the US – with another subvariant already circulating19. Jobs growth has been promising, but available positions are almost five million below pre-pandemic levels20. And with the US stock investors already reacting strongly to the mere anticipation of tighter monetary policy, there is a real possibility of consecutive rate hikes triggering a market event.
The takeaway? Being too aggressive with rate hikes could jeopardize America’s recovery – and the Fed knows it. This explains its cautious “wait-and-see” approach. The Fed could quickly back away from its hawkish position should the consequences of any rate hikes prove too problematic.
The Long-Term Appeal of Local-Currency Sovereign Bonds Remains Solid
When we zoom out and look at the big picture, we can see that Asia is still the world’s growth engine. The region is expected to account for half of global consumption growth over the next decade21. Inflationary pressures have also been more muted22. Mindful of the lessons of the last “taper tantrum”, Asia’s foreign currency reserves and current account balances are also much stronger. As such, long-term opportunities and resilience remain intact.
Drilling down to Asian local-currency sovereign bonds, and the risk-to-return picture is still attractive, with diversification benefits remaining unchanged. The yield pickup has indeed fallen for certain markets – namely China and Vietnam. For other territories whose sovereign bonds have seen yields push upwards, the yield advantage holds.
For instance, as of 10 February 2022, Indonesia’s 10-year government bond still enjoyed a 4.56% yield pickup over 10-year US Treasuries. Malaysia’s stood at 1.77%, and the Philippines at 3.25%. South Korea’s spread of 0.75% has actually risen since the beginning of the year23 24. All these issues are available at much lower risk levels than their corporate counterparts, with the ongoing saga of the Chinese property sector offering a cautionary tale.
Rate Hikes Could Present an Attractive Entry Opportunity
Monetary tightening will happen this year, although the full extent is still up in the air. Combine this with the continued long-term appeal of Asian local-currency sovereign bonds, and the current environment could present an opportunity for investors to increase their allocations to this asset class.
This is mainly because Asian currencies are expected to strengthen in the second half of 2022 (notwithstanding a hawkish Fed), which would add to local-currency bonds’ total return. Further, China is merely at the beginning of an easing cycle, meaning yields will continue to move downward and prices upward. Now may be an appropriate time for an allocation increase to benefit from capital appreciation. Many foreign investors seem to agree, with foreign holdings of Chinese government debt hitting a record 2.5 trillion renminbi in December 202125.
Looking Beyond the Surface to Identify Opportunities
At the surface level, it makes sense to shy away from Asian local-currency sovereign bonds, given the increasingly hawkish environment. But investors need to look deeper to uncover the opportunities beneath. While Asian local-currency sovereign bonds may appear temporarily disadvantaged, there are still good reasons to lean toward this asset class.
All forms of investments carry risks, including the risk of losing all of the invested amount. Such activities may not be suitable for everyone. Past performance is not a reliable indicator of future performance.
Diversification does not ensure a profit or guarantee against loss.
International Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns.
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