The recent spikes in volatility caused by the escalating global COVID-19 pandemic have shaken markets in unprecedented ways. In response, investors have tried to contain their risk exposure by moving their money into what they perceive to be safer havens. Against this backdrop, we will look at how the flight-to-quality has impacted bond markets, particularly in Asia.
The spreading virus has prompted fears that shutdown of economic activity and supply chain disruptions would lead to significant damage to the global economy. The situation was not helped by Saudi Arabia's decision to launch an oil-price challenge against Russia, which caused energy prices to tumble.
Since then, markets have been highly unsettled, even as governments and central banks around the world announced supportive measures.
We believe that higher levels of volatility will remain a fact of life until markets can establish a clearer picture of when the pandemic's peak point will be reached.
Central Banks Take Unprecedented Action
Governments and central banks have responded to the rapidly changing situation by taking aggressive and unprecedented actions to protect individual economies. The US Federal Reserve (the Fed) announced emergency rate cuts of 150 basis points (bps) in total, which brought rates down to 0%.
The Fed's moves were mirrored in other countries, with the European Central Bank and Bank of Japan both announcing accommodative measures, while the Bank of England cut rates by 50bps and introduced a term-funding scheme. Elsewhere there was policy easing in New Zealand, South Korea, Australia, and, more recently, Thailand.
Global fiscal coordination within the European Union (EU) and across other regions must support income, credit lines, insurance and basic health care for the vulnerable. Germany's offer to help Italy and issue EU-wide debt is a positive step in this direction.
In addition, the US Senate and House of Representatives approved a US$2.2 trillion aid package – the largest in history – targeting mortgages, student loans, credit cards and public housing. It should set the tone for other countries.
Investors Find an Unexpected Haven in Chinese Bonds
While global stock markets have plunged, the surge in safe-haven demand has primarily benefitted bond markets. Yields have fallen, with the 10-year US Treasury yield dipping below 1% in March. However, as the situation deteriorated, market volatility began to simmer in bond markets too. What's more, investors have been flocking towards cash, resulting in a change of direction for bonds and a sell-off in mid March; yields on US, German, and UK government debt climbed sharply.
Asian bonds were also initially supported by global central bank easing, but they have not been immune to the recent sell-off. However, Chinese bonds have followed a different trajectory. Due to China's aggressive moves to ringfence the spread of the virus, and the fact that new cases in the country have been declining, investors now view China as a more resilient and a somewhat unlikely "haven" amid the virus-linked sell-off. As a result, Chinese government bonds have rallied. The yield premium that the asset class continues to offer is a bonus for investors, especially in the lower-for-longer rate environment. South Korea also offers a glimmer of hope, as the country appears to be containing the epidemic.
It is worth taking a pause to evaluate the performance and ponder on the fundamentals of Asian local currency bonds vis-à-vis the other peers especially in turbulent time like this. For the month of March, Asian local currency bonds returned -3.31%, while Asian credit in USD returned -5.83% and the global emerging market local currency bonds returned -9.67%.1 The stronger fundamentals, market structures and dynamics of Asian economies and bond markets are some of the main factors underpinning the resilience of Asian local currency bonds. This is a crucial point of consideration for investors seeking to diversify their portfolios as Asian bond markets continue the positive momentum of market reforms.
Higher Volatility Will Continue; Selectivity is Key
There is the potential for market rallies on the back of policy surprises from central banks. However, we also expect to see a slew of downbeat data on the negative impact the outbreak is having on the world’s economies, including downward revisions to earnings estimates and declining PMI figures. This inevitable economic fallout will likely further accentuate the differences between territories with strong fundamentals and those that are more vulnerable to black swan events.
1 Source: State Street Global Advisors, data as of 31 March 2020. The return of Asian local currency bonds is calculated based on Markit iBoxx ABF Pan Asia Index. The return of Asian credit is calculated based on JP MorganAsia Credit Index. The return of global emerging market local currency bonds is calculated based on JP Morgan GBI-EM Global Diversified Index
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