Insights

Bond Market Caution Amid Rising Inflation

Caution in Asian bond markets as investors eye rising inflation and a COVID-driven slowdown in China.


SSGA Fixed Income Portfolio Strategists


Overall, Asian bond markets delivered a small positive return in May 2022. The Markit iBoxx ABF Pan-Asia Index returned +0.15% on an unhedged basis in United States dollar (USD) terms, while it was up +0.11% on a USD hedged basis. The region’s central banks remained focused on inflation while keeping an eye on the potential economic impact of lockdowns in China.

Market Local-Currency Return Foreign-Exchange (FX)  Return Return (in USD)
Korea 0.08% 1.52% 1.60%
Malaysia 2.13% -0.62% 1.50%
Hong Kong 0.65% -0.02% 0.63%
Singapore -0.72% 0.76% 0.03%
China 0.78% -0.92% -0.15%
Thailand -0.32% 0.12% -0.20%
Indonesia -0.31% -0.64% -0.95%
Philippines -2.67% -0.29% -2.94%

Interest Rate Rise in Korea as Central Bank Targets Inflation

In Korea (+1.6%), the central bank raised interest rates by 25 basis points (bps) to 1.75% at the May policy meeting. Following its decision, the Bank of Korea’s governor indicated that the market’s interest-rate expectations of 2.25-2.5% by year end was in line with the bank's, given its focus on tackling inflation. Local-currency bonds were mostly flat as the rate rise had already been priced in. However, the foreign-exchange (FX) element strengthened on a slightly more positive outlook for the economy, given improvements in the services sector driven by a relaxation of social-distancing measures.

Underlying Economic Strength Buoys the Malaysian Market

Malaysia (+1.5%) saw local-currency bonds reverse part of last month’s losses as Bank Negara Malaysia raised interest rates by 0.25%. Explaining its decision, the central bank cited ongoing strength in the domestic economy and reassured markets that its return to more ‘normal’ monetary policies would be measured and gradual. Also, the unwinding of COVID-related restrictions, a strong labor market, improved income prospects, and favorable terms of trade in the agricultural sector mean the economy should be able to cope with any unexpected events.

Positive Bond Returns in Hong Kong Mirror a Similar Rise in the US

In Hong Kong (+0.63%), local-currency bonds saw modest strength, which was in line with bond performance in the US, whose monetary policy Hong Kong mirrors. Meanwhile, the FX element was flat. The government downgraded Hong Kong’s growth forecasts for 2022 to 1%–2% (previously 2%–3.5%), noting that even as its fifth COVID wave slowly eases, the economy remains under pressure due to weak consumer spending, a lack of tourism, and a separate COVID outbreak in mainland China, which has disrupted trade.

Growth Caution and Rising Inflation in Singapore

Singapore (0.03%) was essentially flat, with local-currency bond returns and the FX segment offsetting each other. In its latest economic survey, the Ministry of Trade and Industry (MTI) left the official 2022 gross domestic product (GDP) growth forecast unchanged at 3%–5%, noting that growth would likely be in the lower half of the range. Driven by higher food and utility costs, Singapore's core inflation rose to 3.3% in April, the fastest pace in a decade. However, MTI believes it will peak at 4% in the third quarter of 2022 before moderating later in the year. Market participants also expect the Monetary Authority of Singapore to tighten FX policy settings at its October meeting.

China Experiences Subdued Consumption and Rising Unemployment

Meanwhile, in China (-0.15%), the COVID situation improved, but economic activity remained still below pre-Shanghai lockdown levels, and China’s GDP growth forecasts for 2022 saw further downgrades: the market now believes the economy will expand by 4.7% year on year (from 5% in April). Retail sales and services consumption remained subdued, and unemployment saw a surge in April. Furthermore, analysts believe that the amount of money banks must keep in reserve will be cut by 25 bps–50 bps in the second half of 2022. They also do not think the People’s Bank of China will cut interest rates but instead focus on lending to small and medium-sized enterprises (SMEs), the housing market, and infrastructure projects. China’s FX element has been weaker due to outflows from overseas bond investors, plus some of the advantages of holding higher-yielding Chinese bonds have disappeared.

Stronger-Than-Expected Growth in Thailand

Thailand (-0.20%) saw year-on-year consumer price inflation slow to 4.65% in April (5.73% in March). However, this is still above the Bank of Thailand’s (BoT) target range and is expected to remain high due to persistent price pressures in energy and food. Conversely, inflation driven by demand in the economy remains mild, so the BoT isn’t expected to raise interest rates just yet. In other news, year-on-year GDP for the first quarter of 2022 rose by 2.2% (1.8% in the fourth quarter of 2021). This was higher than the 1.7% growth expected by the market. The BoT believes that full-year growth will be 3.2%, given a boost from the tourism sector – one of the primary drivers of Thailand’s economy is starting to recover, as on-arrival COVID tests have been scrapped.

Indonesian Bank Liquidity in Focus

In Indonesia (-0.95%), the central bank left interest rates unchanged at 3.5%, which was in line with market estimates, and announced an increase in the amount of money banks must hold in reserve (up to 9% by September from 6.5% previously). The latter move should absorb IDR110 trillion in liquidity. Bank Indonesia (BI) Governor Perry Warjiyo acknowledged that even though he expects a total of 250 bps in rate hikes by the US Federal Reserve this year, followed by another 50 bps of increases in 2023, the bank won’t immediately raise its policy rate, preferring to normalise liquidity conditions first. This news led to a slight weakening in local-currency bonds and the FX segment.

Unexpected Rate Rise in the Philippines

Philippines (-2.94%) saw local-currency bonds underperform as Bangko Sentral ng Pilipinas (BSP) hiked the overnight borrowing rate to 2.25% at its May meeting. The move was somewhat unexpected, as market participants believed that the BSP would be prepared to tolerate higher inflation for a few more months. BSP expects inflation to rise by 4.6% in 2022, an increase of 30 bps from its March forecast. This estimate rests on an average crude oil price of USD100 a barrel. The central bank also stated that its ability to support the economy has considerably narrowed.


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