A monthly review and outlook of the Asian Quality Bond market.
Market review - as at October 2023
Geopolitical tensions in the Middle East dominated headlines early in the month as Israel launched into a war against Hamas, the militant group responsible for a surprise attack on Israel, but any risk-off sentiments was overshadowed by the higher-forlonger rhetoric led by the Federal Reserve. The Asian credit market returned -0.65% in October, driven by negative returns both in Investment Grade (IG) and High Yield (HY) credit. Credit spreads in Investment Grade (IG) Asian credit remained in tight territory and compressed further by 3bps, but this was offset by the rise in US treasuries across the curve, resulting in overall negative returns of -0.67%.
Most IG Chinese credits benefited from solid technicals and news of further stimulus being announced in China. Chinese technology names in particular responded positively as credit spreads tightened across the curve. Among asset management companies, Huarong bonds rallied across curve on the back of company’s continued bond buybacks. On the other hand, IG rated developers including Vanke and Longfor saw prices falling due to lackluster national sales recovery and contagion from liquidity issues coming from Gemdale’s, another high-quality developer, liquidity issues. In other bond market events, PTTGC, Thailand’s flagship petrochemical company, announced plans to repurchase bonds as part of its bid to reduce gross debt. This move came on the back of Moody’s negative rating action in August 2023, and signaled to the market the company’s adequate finances.
Longer-dated Indonesian investment grade sovereign and quasi-sovereign bonds saw spreads continuing to edge tighter. However, positive returns were nullified by the sharp spike in US Treasury yields in early October. There was some reprieve in the middle of the month but volatility and the sustained rise in US Treasury yields that returned at the end of October meant that returns in investment grade sovereigns continued to remain challenged.
Month on month, primary issuance fell both in terms of total issuer volume as well as issuance size. Issuance activities for USD credit resided with only Chinese and South Korean issuers, namely from financials such as ICBC and Korea Development Bank. By quantum, Green bonds comprised approximately 25% of these new issuances.
Q4 2023 investment outlook
The upbeat tone that underscored most of the first half of 2023 faced some challenges as we entered the second half of 2023. Even as prices remained high across developing economies, headline inflation numbers dampened as compared to the previous year. However, growth in Europe showed signs of faltering, and China’s slowdown loomed like a dark cloud over the horizon even as the US economy printed strong numbers that portrayed strong consumption, wage growth and still low unemployment numbers. We saw more downgrades than upgrades in the overall Asian credit space, although fundamentals have remained mostly intact amongst high quality credits. In supply technicals, the primary market issuance for Asian Credit remains extremely slow, providing additional price support for credits as tightening spreads helped offset the rise in interest rates.
We expect the second half of the year to be more revealing of actual economic conditions as the effects from policy transmission surface with more clarity. It is difficult to fathom rate hikes amounting to more than 500bps not having any effect on the US economy. We attribute a large part of stronger than expected headline growth to a sharp increase in household debt in the form of credit card and home equity loans, rather than a robust job market and strong wage growth. In an already debt-fueled economy, more restrictive credit conditions will also further restrict growth as interest rates stay elevated for the near future.
In the US, we believe we are close to the end of the current rate hike cycle. Cooling signs in core inflation numbers offer the Fed an opportunity to take a pause and assess the impact of the past year of rate hikes before deciding on their next step. However, the historically low unemployment rate also lead us to believe that Fed will unlikely cut policy rates this year. Barring a sharp deterioration in US economic growth, the US Dollar may stay strong in the coming quarter as long as it maintains a favorable interest rate differential against the EUR and JPY. Bank of Japan’s next move should be closely watched as any signs of change to its Yield Curve Control policy will have significant implications for the course the dollar’s strength. Within the region, we have turned cautious on Asian currencies as they are now vulnerable to a US, China or global recession scenario as risks and uncertainties continue to mount.
China’s slowdown has led to ripple effects across Asian economies. The growth outlook in Asia is showing signs of weakness especially for exports oriented countries including Singapore, South Korea and Taiwan. This also suggests that global demand including those from developed economies have been weak and are likely to stay lackluster. Barring a major stimulus from China, headwinds from China’s slowdown would inevitably mean a prolonged period of weak exports numbers from Asian economies. Countries with a stronger domestic story, such as India and Indonesia, are likely to fare better.
The fall of industry stalwarts in China’s property space has been alarming, to say the least. Until Chinese regulators come through with stimulus significant enough to inject optimism to the property market and increase property sales, default risk remains high among private and mixed ownership developers. With continued weakening of technicals and deteriorating fundamentals, we see a low probability of strengthening in the property sector in the short term. While the default of Country Garden hasn’t been our base case scenario, the market bloodshed could turn uglier and imply the intent of Beijing to let natural selection run its course. On the upside, albeit painful, this would also mean an acceleration of the consolidation of China’s property sector in the longer run.
Inflation in Asia has thus far been fairly under control when compared to developed markets, giving Asian central banks more flexibility to pause rate hikes and potentially cut rates to spur growth should the need arise. There are clear signs that inflation in most Asian countries are likely to continue trending lower, unless food and energy inflation rear its ugly head and cause a spike in headline inflation. We remain constructive on the region’s longer-term growth prospects as Asian economies continue to move up the value chain in the global economy.
We adopt a cautious tone in Asian IG credit and remain selective in Asian High Yield. With signs of slowing earnings and weaker economic activity in the region, fundamentals of Asian Investment Grade (IG) corporates remain sound. However, considering the mounting macro uncertainty, valuations are starting to look rich, despite modest weakening in Asian IG credit metrics within still solid territory. Nevertheless, high all-in yields well above 5% does makes this asset class attractive from an income carry perspective. Our bias is to look for idiosyncratic and relative value opportunities. In Asian High Yield (HY), survivors in the Chinese high yield property sector may provide short-term trading opportunities. Significant upside returns potentially reside among distressed names who survive the debt restructuring process, and these names could benefit from improvement in pre-sales figures.
Source : Company data, First Sentier Investors, as of end of October 2023
Investment involves risks, past performance is not a guide to future performance. Refer to the offering documents of the respective funds for details, including risk factors. The information contained within this material has been obtained from sources that First Sentier Investors (“FSI”) believes to be reliable and accurate at the time of issue but no representation or warranty, expressed or implied, is made as to the fairness, accuracy or completeness of the information. To the extent permitted by law, neither FSI, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from any use of this. It does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment. The information in this material may not be edited and/or reproduced in whole or in part without the prior consent of FSI.
This material is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong. First Sentier Investors, FSSA Investment Managers, Stewart Investors, Realindex Investments and Igneo Infrastructure Partners are the business names of First Sentier Investors (Hong Kong) Limited.
First Sentier Investors (Hong Kong) Limited is part of the investment management business of First Sentier Investors, which is ultimately owned by Mitsubishi UFJ Financial Group, Inc. (“MUFG”), a global financial group. First Sentier Investors includes a number of entities in different jurisdictions.
To the extent permitted by law, MUFG and its subsidiaries are not responsible for any statement or information contained in this material. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment or entity referred to in this material or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.