Asia Pacific Head of Fixed Income, Head of SSGA Singapore
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.
Reversal in US Treasury Yields Raises Questions Surrounding the Safe-Haven Narrative
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.
Safe Havens Imply Diversification – Something Asian Government Bonds Provide
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.
Any Recovery in Risk Sentiment Will Benefit Asian Government Bonds
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.
A Smart Total Return Play for Volatile Times?
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.
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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Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
The example mentioned is for illustrative purposes only.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
Assets may be considered ""safe havens"" based on investor perception that an asset's value will hold steady or climb even as the value of other investments drops during times of economic stress. Perceived safe-haven assets are not guaranteed to maintain value at any time
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
The views expressed in this article are the views of Kheng-Siang Ng through the period ended 31 March 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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