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Higher US Yields Spur Asian Local-Currency Bond Sell-Off

The appeal of Asia’s bond markets waned, as United States (US) Treasury yields spiked in late February, igniting fears of a second “taper tantrum.” Other than just reacting to stronger-than-expected economic growth and US inflation prospects, Asian markets also had to contend with their own inflationary concerns and weaker-than-expected economic indicators.

SSGA Fixed Income Portfolio Strategists

March 19, 2021

Asia’s bond markets delivered negative returns in February, with all index constituents generating negative returns. The Markit iBoxx ABF Pan-Asia Index was down by -1.77% in US dollar (USD) terms on an unhedged basis and -1.59% on a USD hedged basis. Specifically, Thailand was the worst performer and China the best.

No Shot in the Arm for Thailand

Thailand fell by -3.57%, with local-currency bonds (-3.08%) weighing on returns. Weakness in recent economic indicators reflected the introduction of restrictions to contain resurging COVID-19 cases and delays to the vaccination programme that will further postpone plans to reopen the country’s borders. The Thai market has adjusted to the sharp move higher in US real rates with a repricing of local-rate premiums.

Demanding Investors

Meanwhile, the Philippines was among the worst performers returning -2.90%, primarily due falls in local bonds (-2.01%). This was underpinned by investor demand for more risk premium in the form of yield – a move that following an increase in headline inflation, which jumped to 4.2% year-on-year in January. The surge breached the central bank’s 2-4% inflation-target band: food prices rose sharply (6.2%) in the wake of a recent typhoon, as did transportation costs on the back of higher oil prices.

A Cutting Response in Indonesia

Farther south in Indonesia, bond markets returned -2.67% over the month, with local bonds (-1.21%) and foreign exchange (FX) (-1.47%) both acting as a drag. Despite the Bank Indonesia cutting its policy rate by 25bps to 3.50%, Indonesian assets were still negatively affected by rising US yields. Of note, foreign investors, who have a relatively large presence in the country’s bond markets, grew concerned about potential outflows.

Easing of Supportive Measures

Neighbouring Singapore saw it bonds dip by -2.22% over the month in USD terms, almost entirely due to the local-currency-bond component (-2.45%). The sell-off was in tandem with other global bond markets, as vaccination developments helped to boost global economic prospects. In February’s budget presentation, the government trimmed its aggressive fiscal support stance adopted when the COVID-19 crisis was at its worst. Market participants retain their view that the rate-setting Monetary Authority of Singapore (MAS) will leave FX-policy settings unchanged at its next review.

Higher Oil Prices Present Inflationary Risks

Malaysia posted a decline of -1.93%, with the fall primarily driven by weaker local bonds (-2.01%). The country’s COVID-19 situation appears to be under control, with daily cases declining from their end-January peak. While market participants expect Bank Negara Malaysia to leave its policy rate unchanged at 1.75%, they appear to be demanding more term premium from bonds, as near-term inflation expectations are higher due, in large part, to higher oil prices.

Feeling the Pressure of Higher US Rates

Turning to Northeast Asia and Korea’s bond markets fell by -1.67% in February. In a similar vein to other markets, this was mostly driven by a declining local-bond segment (-1.24%). Although the Bank of Korea maintained its 7-day repo rate at a record low of 0.50%, rates still sold-off and curves steepened due to pressure from higher US rates, improving economic data, and higher bond supply.

Economic Optimism in Hong Kong

Hong Kong’s bond markets returned -1.38% over the month, with the local-currency component detracting by -1.34% on expectations that the swift effects of a vaccine rollout programme and fiscal-stimulus would support
an economic recovery.

Manufacturing Leads the Way

In China, bonds experienced a more marginal decline (-0.31%) over the month. With the most recent COVID-19 outbreak in the country’s Northern provinces under control and a further relaxation of containment measures, markets are optimistic about the continued economic recovery, led by the manufacturing sector. Investors also expect near-term economic policy to remain accommodative before monetary and fiscal supports gradually taper in the second half of the year.