As the Russian-Ukraine war continues to roil global markets, few know what will happen next. But what are the implications for Asian bonds as an asset class?
In late February 2022, as the Federal Reserve (Fed) prepared to embark on its course of progressive rate hikes, global markets were shocked by a significant and unexpected event – Russia’s invasion of Ukraine.
The impact was swift. Share prices – already reeling from the anticipated Fed rate hikes – saw their losses extend further. And US Treasury yields fell by almost 30 basis points in the week following the invasion1 as investors sought safe-haven assets.
However, as the war dragged on, the picture shifted. While stocks are generally still down for the year, there were periods in the ensuing weeks where they posted robust – if temporary – recoveries. However, it was the behavior of US Treasury yields that captured particular attention.
The immediate post-invasion plunge in US Treasury yields was short-lived. Hawkish statements by the Fed amid unabated inflation led to expectations of further rate hikes that more than offset any safe-haven inflows into US Treasuries2. At the beginning of March 2022, yields began a sharp and sustained rise that saw them jump by 84 basis points in just over a month3. They now stand at levels last seen in the first quarter of 2019.
These data points reveal essential questions: Can US Treasuries still be considered a refuge in a tightening monetary environment? Would investors still want to park their money in Treasuries knowing that yields will likely increase in the near term?
While these points have yet to be clarified, the US Treasury safe-haven narrative is far from certain in the current environment. That leads to another critical question: If not US Treasuries, where else can investors find refuge amid market volatility?
It could be suggested that Asian bonds – specifically Asian government bonds – may provide the answer.
What happens in the US economy affects the entire world. This makes diversification a critical characteristic of any safe-haven asset. With the Fed firmly set on a tightening path, investors should look to markets that can do the opposite.
And among the major economies, there is only one capable of resisting the monetary tightening path set by the Fed – China. Last July, the People’s Bank of China (PBOC) slashed its reserve ratio by 50 basis points4. A few months later, in October, it pumped almost a trillion renminbi of liquidity into the banking system5. Then in late January this year, it cut benchmark rates across the board6.
Therefore, it’s no surprise that analysts believe that rate cuts are far from over7. This is mainly because Asia’s inflationary pressures have been less severe than the West, implying space for further easing8. In short, the region’s government bonds can offer true diversification – something in short supply in an increasingly interconnected world.
Thanks to the Fed, it seems highly unlikely that US Treasury yields will go anywhere but up this year. This isn’t the case for Asian government bonds. As they are not traditionally thought of as safe-haven assets, any recovery in risk sentiment is likely to attract strong inflows – creating a significant potential for capital appreciation.
For instance, despite the global “risk-off” sentiment in February this year, Asian sovereign bonds still saw foreign inflows – their 21st month in a row9. Should risk appetite improve, these inflows seem likely to rise, which would lead to an increase in prices. Except for China, prices of Asian government bonds have generally fallen this year10, meaning now may be an ideal entry opportunity. And even for China, prices still have a good chance of appreciating as the PBOC resumes its path of monetary easing.
Then, there’s the currency aspect. While the US dollar has maintained a strengthening path for most of the year, we could soon see local Asian currencies rally in the latter half of 2022. Many markets in the region have robust current-account balances, and this currency appreciation would only add to their potential total returns.
Geopolitical uncertainty is surging, a move that typically sees investors pivot toward safe-haven asset classes. Yet, with a hawkish Fed trying to tamp down rampant inflation, things are different this time, and investors moving into US Treasuries may quickly find themselves burned by rising yields.
In such an environment, market participants may want to consider alternative options. Asian government bonds, with their diversification appeal and potential for positive total returns, could just fit the bill.
1. https://www.cnbc.com/quotes/US10Y (from 25/02/22 to 01/03/22)
3. https://www.cnbc.com/quotes/US10Y (from 04/03/22 to 07/04/22)
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Diversification does not ensure a profit or guarantee against loss.
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