Market Views: Fixed Income
Outlook 2019: Asian bonds
We expect that the US dollar’s strength should fade in 2019 as the pace of US rate hikes begins to slow, which will ease the pressure on Asian bonds next year.
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- The Asian bond market has been hurt in 2018 by robust US growth and a more hawkish Federal Reserve, but this headwind should fade in the coming year.
- The ongoing US-China trade war remains a risk to watch but opportunities are still present. Country and credit differentiation will be key.
- Corporate bonds from a number of robust issuers with strong balance sheets have sold off aggressively this year, and this provides a number of opportunities.
The US spent much of 2018 exceeding expectations. Growth in the US economy was stronger than expected. Interest rates rose more rapidly than expected, leading to a stronger-than-anticipated US dollar (USD). In combination, these factors have created much angst for Asian bond markets, resulting in negative performance.
At the same time, the region has had to grapple with a slowing Chinese economy, mostly as a result of the country’s efforts to reduce debt in the financial sector over the past two years. That is to say nothing of the trade war with the US, which has weighed on domestic business confidence and dominated headlines. Asian currencies and higher yielding bond markets - such as Philippines, India and Indonesia - are more vulnerable to USD funding, and took the brunt of the repricing. Consequently, while valuations for the region have become more attractive, fundamentals have remained solidly intact.
Going into 2019, we expect the USD strength to wane, easing pressure on Asian currencies. This is especially true for India, Indonesia and the Philippines, that have struggled the most this year, even though the outlook on global growth remains uncertain and China may slow further still.
The pause in the upward USD trend should provide breathing space for the central banks in Asia to adjust monetary policy to limit any further downside to growth or currency weakness. With regards to China, we believe it would be positive for the Chinese bond market if policymakers continue to engage in further reserve ratio requirement (RRR) cuts and provide further targeted stimulus to stabilise growth. We expect these policy actions - such as further RRR cuts - would support the Chinese economy in early 2019. This should in turn be a positive for other countries dependent on trade with China in the region.
Trade war ceasefire?
The ongoing trade war between US and China is not likely to see a resolution soon. However, tensions appear to have eased slightly. Both sides seem eager to limit the trade wars’ negative impact on growth of their respective economies. We believe this paints a constructive backdrop for Asian currencies and local currency sovereign bond markets, as markets are still pricing in a deterioration of the situation.
In terms of USD denominated (hard currency) credit markets, trade related tensions may have slowed the strong economic growth witnessed last year. However, it is worth noting that a large part of the Asian USD denominated credit universe comprises issuers that do not have export driven businesses. We expect domestic conditions across a large swathe of the emerging Asian universe – China, India, Indonesia, Philippines and Thailand - to continue to power ahead in 2019. The flip side of this is of course that the more export oriented economies of Hong Kong, Singapore, South Korea and Taiwan could experience a slowdown.
Hence, performance is likely to be differentiated amongst countries in the region given the differing economic dynamics. With less pressure from a rising USD and the likelihood of much more gradual US monetary policy normalisation from here, regional Asian central banks are likely to ease off on their monetary policy tightening bias. This should then ease the cost of funding pressures for corporates in their local markets.
Fundamental strength key to returns
Credit fundamentals of investment grade Asian economies continue to be robust. Most have strong reserves and fiscally prudent policies that should enable them to continue to weather volatile macroeconomic conditions. Similarly, we expect credit fundamentals for USD denominated investment grade corporate bonds to remain robust with South East Asian companies likely to hold up better than their North Asian counterparts. Across both the investment grade and high yield space, credits with solid fundamentals have seen a significant weakening in prices due to numerous factors (the oil price, Fed guidance, policy risk etc.) and could be a good place for investors to look for positive medium to long-term returns.
We see a number of opportunities currently in Indonesian and Chinese high yield companies. Within the USD denominated high yield universe, Chinese property issuers constitute the largest part of the market and we expect to see a divergence in credit fundamentals amongst these issuers as a tougher operating environment separates the strong from the weak due to refinancing concerns. However, increasing evidence of Chinese policy support to address these concerns should help boost investor confidence and see sentiment improve as we progress through 2019.
The realities of quantitative easing in Europe ending means investors are likely to remain relatively cautious in the New Year. That said, we also doubt an extreme “risk off” scenario will develop, as signals that portend a global recession remain largely absent.
In the coming year, our focus will be to emphasise selectivity and pick countries and companies with robust balance sheets that have wide access to financing channels. With yields ranging from 2% to 9% across the credit quality spectrum in USD and Asian currencies, and the increasing possibility of a peak in US rates, we believe that Asian bonds provide fertile ground for investors seeking high quality capital gain and yield in 2019.
This article is part of our Outlook 2019 series. The previous articles in the series - including Asia ex Japan equities - can be found by clicking the links below: