As bond markets face volatile conditions, investors are increasingly seeking stability. In that respect, Asian sovereign debt could provide a solution.
Inflation remains the talk of the town, and the Federal Reserve (Fed) is more than serious about tackling rising prices. After raising its benchmark rate by 0.25% in March, the Fed followed up with a 0.5% hike in May – and signalled that consecutive 0.5% hikes at its subsequent meetings are likely1. Other central banks are also tightening, with many having little choice but to follow the Fed’s lead.
As a result, global bond markets have been under pressure, with yields spiking across the board – based on the Bloomberg Global-Aggregate Total Return Index, April was one of the weakest months on record2. This environment also creates severe volatility as rising yields lead to shifts in asset allocation and changing capital flows.
This could only be the beginning. While the latest inflation data from the US showed that it had fallen slightly from 8.5% to 8.3%, the market expected a more significant drop3. This means there is still plenty of room for yields – and consequently volatility – to continue rising in the near term as the Fed tightens further.
Given the current climate, it may be wise for bond investors to consider shifting their priorities toward more stable assets. This is especially the case for those unwilling to abandon bonds altogether or seeking returns at all costs by turning to the riskier high-yield market – especially given the uncertain macroeconomic outlook.
The question is this: as global inflation and a tightening Fed pressure central banks to raise rates, where can bond investors turn to in search of greater stability? One sub-asset class worth exploring is Asian local-currency government bonds.
As a beneficiary of trillions of dollars of pandemic-driven quantitative easing, it’s no surprise that inflation is higher in the US compared to many countries. This has also made it a political hot-button issue. The Fed has been more aggressive with rate hikes than its peers in response.
While Asia has seen a lift in inflation, the region’s dynamics are significantly different. For one, inflation is less pronounced. In Southeast Asia, inflation was around 3.5% in March4. Meanwhile, Korea’s decade-high inflation rate is still only in the 4% range5; and Taiwan remains below 3.5%6. China, with its stringent COVID lockdowns disrupting supply chains, posted consumer inflation of 2.1% in April while producer prices dipped7.
Second, the economic dynamics are also different. Much of Asia is still highly export-driven, which means that currency weakness – a likely outcome of the Fed’s tightening cycle – can be a positive. This is in stark contrast to the import-dependent US, whose trade deficit recently hit a record US$109.8 billion8. Raising rates helps, as it contributes to dollar strength and leads to cheaper imports.
These factors provide a buffer for Asian central banks to resist the pressure to raise rates, giving them space to do so at a more measured pace. Powerful economies like China can go one step further. While the People’s Bank of China left policy rates unchanged in April, it lowered the reserve requirement ratio for banks and continued to signal a supportive stance toward monetary policy9.
One thing many bond investors underappreciate are the supply-demand forces that influence the market. This has lent further credence to Asian local-currency sovereign bonds as a shelter from volatility. In Europe, where the ECB has exhibited a much more dovish stance than the Fed, bond supply looks set to increase.
For instance, although the EU’s debt and deficit constraints – laid out as part of its Maastricht Treaty – are suspended to allow member states to fight the pandemic. These constraints are due to return in January 2023, with some member states pushing for a loosening of the rules10.
The Russia-Ukraine war is also likely to increase Europe’s fiscal spending. The International Monetary Fund (IMF) recently noted that fiscal spending, such as higher unemployment insurance and lower tax payments, should be allowed to “operate freely” to deal with supply shocks. And while the IMF also acknowledges that this will widen fiscal deficits, it openly stated that more fiscal policy might be needed to support economies should significant risks materialise11. All these are separate from direct fiscal support to Ukraine12.
These wider fiscal deficits are likely to lead to higher bond supply – resulting in lower prices as per the law of supply and demand. It’s true that Asia faces its own fiscal challenges, but budgetary issues stemming from the Russia-Ukraine war make it more attractive on a relative basis.
As bond markets across the globe face negative price pressures, it is worth thinking about whether to keep yield as a number one focus. US Treasuries offer attractive yields compared to their risk, but these will probably continue to rise. Similar dynamics are in play in Europe, albeit for very different reasons – plus, yields there are lower than in Asia.
Meanwhile, other higher-yielding segments of the bond market – such as corporate bonds, high-yield issues, or Latin American sovereigns – may simply not be worth the risk in the face of heightened uncertainty. That leaves Asian sovereign bonds as an ideal portfolio diversifier, a refuge that provides stability in the choppy waters of the bond market.
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 30 April 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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