Asian Fixed Income: Pockets of Opportunity
Emerging market debt (EMD) is suffering amid the ongoing global turmoil for several reasons. First, it’s considered a risky asset, thus investors have been exiting EMD for safer investments even though many central banks have cut rates and started asset purchases. Second, the grab for yield and relatively strong performance of emerging market funds means investors were ‘long’ EM investments ahead of the turmoil. Third, the aggressive bounce in the USD has had a big impact on local currency debt. Finally, a number of emerging market economies are heavily exposed to commodities and suffered when oil prices fell sharply.
Year to date, Chinese bonds performed well compared to their emerging market peers, with the country recording both FX and price gains. Rate cuts from the central bank and an aggressive early lock-down to contain COVID-19 supported bonds but cannot explain fully the outperformance. This stability appears to be more about the CNY’s growing importance as a reserve currency and the fact that Chinese bonds have been adopted domestically as an alternative safe haven to U.S. Treasurys just as foreign investors are increasing investments into Chinese renminbi bonds.
The broader Asian bond markets are being pulled in opposite directions. On one hand, continued monetary easing is depressing yields as central banks slash interest rates to revive stalling economies. On the other, the global flight to safety is pushing yields up as some foreign investors exit certain Asian bond markets. Foreign outflows from Asian bonds totalled US$17.28 billion in March – the highest since January 20131.
Such mixed driving factors of Asian bond performance can give the impression of greater and ongoing volatility for the asset class. But Asian bonds are not a monolithic entity. These contradicting forces affect each sub-category differently. This diversity creates potential pockets of opportunity.
Asian Bond Market Divergence
After weeks of battling it out, OPEC+ nations – except for Mexico – reached a historic agreement on 10 April 2020 to cut crude oil production 10 million barrels per day beginning May. However, this did little to support oil prices, which fell below US$20 per barrel at one point. The size of the crude oil glut was also starkly revealed when an expiring May contract for West Texas Intermediate crude fell into negative territory on April 20, driven by fears that there would be nowhere to store the delivered oil.
The prospect that oil prices will remain depressed is a near-term boon for most Asian countries, including China, the world’s largest net oil importer, Korea and Taiwan. Exceptions are net exporters such as Malaysia, Vietnam and Brunei.
The drop in energy prices also offsets the impact on inflation, as a number of emerging market currencies have weakened significantly in the past months. The combination thus far means that headline inflation is still headed lower. This will provide central banks with more room to ease monetary policy, which could place further downward pressure on bond yields.
The impact of a strong U.S. dollar on Asian bonds amid the global flight to safety also affects each country differently. Countries like Indonesia and India, which have twin deficits in their budget and current accounts, are more reliant on foreign inflows and thus more exposed.
Central Banks to the Rescue
COVID-19 presents a different set of challenges versus the previous crises but, crucially, central banks have acted quickly. Rate cuts and bond support programmes were initially deployed to limit the worst effects of the economic slowdown on households and businesses.
A key objective for central banks is to keep credit flowing to corporates. In China, which remains the brightest star in the Asian bond constellation, first-quarter corporate bond defaults fell 30% year-on-year as the government pressured banks into keeping enterprises floating with easy financing2.
On the other side of the globe, bond buying programs for corporate bonds have been reactivated by the U.S. Federal Reserve (the Fed), European Central Bank and Bank of England. The Fed has announced it will also purchase corporate bond ETFs, and more recently, an unheard-of foray into buying bonds that recently lost their investment-grade status – so-called ‘fallen angels’.
Potential Attractive Entry Opportunities
Despite contradicting forces on Asian bonds and divergence within the asset class itself, we believe, on balance, that overall yields will trend lower – which may create attractive entry opportunities for those practicing careful asset selection.
Given the degree of the sell-off, there is scope for a rebound. Positive returns in Asian bonds can come through various sources: gradual economic recovery, a rebound in local currency bonds against the USD and central banks starting to buy domestic bonds.
Written by Kheng Siang Ng
Asia Pacific Head of Fixed Income, State Street Global Advisors
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