Asia Pacific Head of Fixed Income, Head of SSGA Singapore
2021 was a mixed year for Asian bonds. There were definite challenges, such as default risk in China’s property sector. Yet there were also bright spots, such as the surge in ESG issuance, which is expected to grow stronger in 2022 1 , and robust overseas interest in this asset class2 .
Before the new year gathers pace, now is a good time to reflect on Asia’s fixed income markets. We will look back at their performance, assess ongoing risks and opportunities, and share how 2022 could play out.
Performance Review – A Minor Yield Dip, With Some Exceptions
In general, local-currency Asian bonds experienced a slight dip in yields in 20213 . However, this slender change did mask some significant fluctuations in value. But when we segregate the asset class into corporate and sovereign bonds, a different pattern emerges. Asian corporate bonds saw a more substantial drop in yields4 , while sovereign bonds primarily saw these rise5 .
The major exception to this trend was Chinese sovereign bonds, which saw yields fall as the country loosened monetary policy by slashing its reserve ratio requirements twice during the year6 . Moving into 2022, the People’s Bank of China is widely expected to ease conditions further to boost economic growth7 , setting the stage for a further decrease in yields this year8 .
Tighter Monetary Conditions – But Asian Bonds Should Remain Resilient
While China appears set on a path toward looser monetary policy, it is a notable outlier. Monetary conditions – both in Asia and worldwide – will likely tighten this year. South Korea, for example, is already ahead of the curve, having hiked interest rates twice last year to quell inflation and dampen rising household debt9 . At the end of 2021, the US Federal Reserve (Fed) signalled a faster tapering of its bond purchases and pencilled-in up to three interest rate hikes for 202210 .
That said, if investors are worried about a repeat of 2013’s “taper tantrum” – when the Fed’s announcement of a deceleration in its quantitative-easing programme sparked a significant selloff in Asian bond markets – then they should perhaps remain calm.
Today, Asian economies are better prepared and, as a result, more resilient. Foreign exchange reserves are healthier, current account balances solid, currencies (presently) undervalued, and yield spreads significantly higher 11,12 . While short-term rates are likely to move up, long-term yields should remain relatively anchored.
That’s not to say tighter monetary policy poses no risks for Asian bonds. Faster-than-expected inflation leading to swifter tightening makes the overall environment more challenging – especially considering new coronavirus variants and pockets of credit-quality lapses.
A More Challenging Environment
While fundamentals today are more robust than in 2013, a tighter economic environment does pose challenges to this asset class. Inflation has been rising in developed markets, and the Fed’s recent hawkish turn represents a significant acceleration over its previous tightening timeline. Should America’s central bank misjudge the state of the US economy, there is a risk it may jeopardize the recovery – something that could also spill over to Asia.
All of this is happening as the Omicron variant is becoming the dominant strain in many parts of the world13 – something the OECD warns may cause a severe global slowdown14 . This could spur flights to safety, drawing capital away from Asian markets, particularly among sectors with riskier credit profiles such as high-yield bonds. We already saw large selloffs in China’s high-yield market in late 2021 after a confidence crisis stemming from heavily indebted property developers15 .
Yet, even amid such an environment, opportunities are emerging in one subsector of the Asian bond market – local-currency sovereign bonds.
Asian Local-Currency Sovereign Bonds Maintain a Solid Investment Thesis
Asian local-currency sovereign bonds saw yields increase in 2021, implying a decrease in prices. However, we think this is positive as we enter 2022, as it means more attractive entry points – especially as the asset class’s investment thesis remains solid.
For instance, the increase in yields signifies an advantageous pickup over US Treasuries, which is a major plus point considering the hunt-for-yield theme still very much holds. For example, as of the end of 2021, 10-year Indonesian sovereign bonds maintained a 4.88% spread over 10-year US Treasuries16 . The yield pickup stood at 1.32% for China, 2.09% for Malaysia, and 3.36% for the Philippines.
Furthermore, by focusing on sovereign bonds, investors can mitigate credit risk while also capturing diversification benefits. Elsewhere, resurgent currency strength and a stronger focus on ESG could also prove to be strong catalysts.
Resurgent Asian Currencies and Increased ESG Issuance
The US dollar strengthened throughout 202117 – a trend we expect to continue into the first half of 2022 as the Fed quickens its tapering and possibly hikes interest rates. Most Asian central banks are unlikely to normalize rates so soon, thus leading to weaker currencies in the initial part of the year.
However, in the second half of the year, this could reverse. Asian central banks are likely to start normalizing rates, and this, coupled with a more substantial economic recovery as vaccine boosters become more widespread, should support local currencies. Such potential for appreciation further underpins the case for entering the Asian local-currency bond space in the early part of 2022.
Finally, we also see ethical issuance gathering strong momentum. Asia may have traditionally lagged in this area, but it is making efforts to bridge the gap. Attempts to bring Asian green bond standards up to par with other regions are ongoing18 , which should help support foreign interest.
An Opportunity for Investors to Capitalize on Asian Fixed Income
With tighter monetary conditions, coronavirus variants, and rampant inflation, conditions do indeed look challenging for Asian fixed income in 2022. However, the flip side of every challenge is opportunity, and this time is no different. For those who understand how and where to look, 2022 could indeed be a great year for Asian fixed-income investors.
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The views expressed in this article are the views of Kheng-Siang Ng through the period ended 31 Decemeber 2021 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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