Fed Policy Moves and Omicron Concerns Underpin Asian Bonds

Asian bond markets moved higher in November 2021 as investors weighed persistently high inflation, reduced US policy support, and the Omicron COVID variant.

SSGA Fixed Income Portfolio Strategists

Local bond markets in Asia saw modestly positive returns in November 2021, with the Markit iBoxx ABF Pan-Asia Index up by +0.19% on an unhedged basis in United States dollar (USD) terms. Meanwhile, the index was up +1% on a USD hedged basis. In most cases, though, foreign exchange (FX) weakness offset these gains.

Jerome Powell, Chair of the US Federal Reserve (the Fed), said that the scale of the US central bank’s monthly economic support program could be reduced more quickly than expected but recognized the potential risks posed by the spread of the Omicron COVID-19 variant and the prospect of persistent inflation as we move into 2022. In response, investors focused their attention on what they perceived to be higher-quality markets.

Market Local-Currency Return Foreign-Exchange (FX) Return Return (in USD)
China 1.18% 0.28%     1.47%
Korea 2.82% -1.63% 1.14%
Hong Kong 0.15%     -0.32%             -0.17%
Indonesia     0.61%     -1.06%     -0.46%
Philippines -0.42%     -0.05%     -0.47%
Singapore 1.30% -1.77% -0.49%
Malaysia 0.91%     -1.77% -0.87%
Thailand     0.58% -1.67% -1.10%

Pressures ease in China’s manufacturing sector

China was the best performing market over the month (+1.47%), with a significant contribution from local bonds. There was positive news flow from the manufacturing sector, which recovered from seven straight months of decline in November. The upturn was driven by government efforts to ease previously stringent power rationing by boosting coal and power supplies. Meanwhile, the market forecasts that year-on-year gross domestic product (GDP) growth will be 8% in 2021 and 5.3% in 2022. However, much depends on the transmission of the Omicron variant, as China’s commitment to a zero-covid policy could negatively affect services and consumption if any new outbreaks occur in the first quarter of 2022.

Central bank clarity in Korea

Korea (+1.14%) reversed the previous month’s underperformance, as bonds rallied when the Bank of Korea (BoK) raised interest rates by 25 basis points (bps) at its November policy meeting. This move was in line with the market’s expectations and clarified how the BoK intends to gradually reduce the level of economic support provided to the economy. The medium-term outlook for bonds depends on the amount and timing of new bond issuance in 2022, as well as inflationary movements. The BoK’s inflation forecast for 2021 was raised by 20 bps to 2.3%, while its expectation for 2022 was increased by 50 bps to 2%.

Higher costs keep investor sentiment in check

Hong Kong declined by -0.17%, driven mainly by FX weakness. Despite a leading measure of economic activity logging ten consecutive months of growth and rising to a three-month high in November 2021, the market’s tone has been relatively lackluster. This muted atmosphere has been underpinned by increasing purchase costs, higher wages, and concerns about tighter border restrictions to avoid the spread of CVOID-19. At the time of writing, Hong Kong has already reported Omicron cases.

Overseas investors grow cautious

Indonesia was down by -0.46%. Although local bonds performed well, this was not enough to offset a decline in the FX element. Bank Indonesia (BI) left interest rates unchanged at 3.5% and continued to downplay the potential impact of the Fed’s decision to reduce the scale of its monthly bond-purchase program. In November, consumer inflation was surprisingly strong, rising to 1.75% (year on year) from 1.65% in October. However, this was still below BI’s 2–4% target range. The FX weakness stemmed from persistent foreign investor outflows and fears that a faster-than-expected withdrawal of Fed support would pressure BI into raising interest rates to defend the rupiah.

Slow but steady recovery in the Philippines

Philippines returned -0.47% amid a modest sell-off in local bonds. The Bangko Sentral ng Pilipinas (BSP) kept its overnight borrowing rate unchanged at 2%, in line with investors’ expectations. The market’s forecast for GDP growth in the third quarter of 2021 rose to 7.1% (year on year), which was higher than the 4.9% previously forecast. This suggests that the most recent community quarantine measures have not impacted growth. BSP also maintained its 2022 inflation forecast at 3.3% but acknowledged that risks remain due to any weather-related impact on food and transport prices, as well as supply bottlenecks.

Safe-haven status attracts investors

Singapore bonds slipped by -0.49% over the month in USD terms, with FX the primary driver of weakness. Local bonds rallied in line with those of other developed markets, and FX (versus the USD) bore the brunt of the more cautious tone. Year-on-year consumer inflation jumped from 2.5% in September to 3.2% in October. Market participants feel that the Monetary Authority of Singapore’s decision to tighten its FX policy settings in October allows it to wait and see how the inflationary situation develops and what the Fed’s next moves will be in 2022.

Inflation should remain moderate in Malaysia

Malaysia lost -0.87%, with most of November’s weakness coming from the FX component. Bank Negara Malaysia (BNM) left interest rates unchanged at 1.75%, in line with market predictions. The finance ministry has assumed GDP growth of 5.5–6 .5% in 2022, up from 3–4% in 2021. Regarding price pressures, the central bank still expects consumer inflation for 2021 to be in the region of 2–3% and believes that headline inflation will "remain moderate" in 2022. Investors think that BNM will leave interest rates unchanged at 1.75% throughout the remainder of 2021 and into the first quarter of 2022.

Currency woes in Thailand

Thailand had a difficult month when its currency, the baht, weakened. The Bank of Thailand kept interest rates at 0.5% in a unanimous decision. Also, Thailand received 20,272 foreign arrivals in October, which was far lower than the 3.3 million visitors received, on average, each month in 2019. Thailand’s manufacturing sector gained ground in November 2021, the second straight monthly rise, on hopes of an economic recovery. However, the arrival of the Omicron variant dampened hopes about the pace of recovery in the tourism sector.