The Fed Turns More Hawkish – Why Asian Bond Investors Should Not be Too Worried

Rising inflation and the recent hawkish pivot by the United States Federal Reserve have sparked concerns about a second taper tantrum in Asian bond markets. But is there any cause for concern?

Asia Pacific Head of Fixed Income, Head of SSGA Singapore

In June 2021, after over a year of ultra-easy monetary policy, the United States (US) Federal Reserve (Fed) surprised markets with a somewhat hawkish pivot. Its “dot-plot” outlook showed that most Federal Open Market Committee (FOMC) members now believe the central bank will hike rates at least twice by end-20231 . This was in conjunction with higher inflation forecasts and statements indicating the Fed would begin discussing the possibility of tapering its bond purchases 2.

You could argue that these moves were too subtle to qualify as ‘hawkish’, but in the current climate, even the slightest move by the Fed is enough to elicit a strong market response. In this case, the announcement jarred, given previous reassurances that tapering and rate hikes were further away. And as inflation in the US continues to hit record-highs3 , worries about the effect any tightening would have on Asian bonds have predictably emerged.

Should Asian bond investors be worried? The data suggests otherwise.

Treasury Yields Moving in the Opposite Direction
A more hawkish Fed would imply a rise in Treasury yields. While the 10-year US Treasury yield did increase by about 10 basis points (bps) to hit 1.57% on 16 June 20214 , it quickly retreated. As of 23 July 2021, it has dipped to 1.29% – a decrease of almost 30bps and a low not seen since February 2021.

The likely explanation for this pivot? Talking is easy. The Fed may have spoken about tapering and raising rates sooner, but in the end, though, it is still just a conversation with no immediate follow-up expected. Meanwhile, more tangible factors are sparking concerns about future economic growth, and that is pushing down yields as investors move toward safe-haven assets.

Chief among these factors is the resurgent coronavirus. Despite a promising start, vaccination programmes have been uneven amid organisational roadblocks or public scepticism, particularly among seniors. One-third of eligible adults in the US have yet to be vaccinated, and the country is now administering less than 500,000 doses a day5 . Cases are again quickly rising, putting a damper on the prospects of a broad-based economic recovery6 . This has been further exacerbated by a surprise jump in weekly jobless claims7 .

Another possible factor is that the Fed’s continued monthly purchases of US$120 billion worth of bonds8 . Considering that the yields on high-yield issues have remained relatively stable9 , the data appears to support the hypothesis that the Fed’s purchases are supporting Treasury prices and pulling down yields.

A Long Way from the 2013 Taper Tantrum
The downward trend in US Treasury yields – even amid a more hawkish Fed and rising inflation – points toward the market being far removed from a repeat of the 2013 taper tantrum.

In that event, the 10-year US Treasury yield spiked by 140bps between May and September 2013, after the Fed suggested it would be pulling back on its bond purchases10 . This spurred heavy capital outflows from many emerging-market bonds, driving up yields. It also negatively affected their stock markets and currencies.

That is not what we currently see. Instead, the Fed’s “taper talk” is outweighed by much more substantial factors affecting yields. And rather than harming Asian bonds, it has provided an unexpected boon.

Yield Pickup is Now Even More Attractive
One of the key attractions of Asian bonds has always been the yield pickup on offer compared with their developed-market counterparts. Now, with declining US Treasury yields, that pickup has become even more attractive – even though the yields on Asian bonds are also generally falling11 . For instance, as of 23 July 2021, Chinese local-currency government bonds now offer a 1.62% yield pickup over 10-year US Treasuries12 . Indonesia’s pickup is 5.01%, while the Philippines’ stands at 2.61%.

So, it’s no surprise that foreign inflows are also surging. June 2021 data showed that foreign purchases of Asian bonds were the highest in two years13 . This was not limited to the higher-yielding markets either – lower-yielding territories like South Korea and Thailand have also seen record inflows14 . Equity markets, meanwhile, are experiencing outflows amid fears of rising coronavirus infections.

Fundamentals are Stronger, but be Mindful of the Risks
Beyond the fact that yields are moving in the opposite direction from what a possible taper tantrum would imply, Asia’s fundamentals are also more robust. With the memory of 2013 still fresh in their minds, the region’s central banks have established buffers to protect against any potential surge in yields: in 2020, US$467.7 billion was added to their foreign exchange reserves – the most since 201315 .

This is not to downplay any challenges. Riskier corporate bonds are indeed more vulnerable to any rise in yields – given their higher indebtedness, greater interest rate sensitivity, and generally shorter duration. By focusing their attention on government bonds, investors can enjoy substantial yield pickup and diversification while keeping risk under control.