Asian Quality Bond Monthly review and outlook

Hawkish moves by the Bank of Japan, accompanied by weaker than expected US economic data triggered substantial market selloffs in risk assets early in the month. The market volatility that ensued heralded in the clear shift of winds that investors have long anticipated — the first cuts in US policy rates by the Fed would finally materialize. Very little room was left for doubt, as Fed Chairman Powell’s dovish Jackson Hole comments later in the month that “the time has come for policy to adjust” affirmed the readiness of the Fed to implement its first rate cuts. What remains a question would be the size of the cuts that would likely remain data dependent. In the meantime, market consensus pointed to a soft landing for the US economy, even as uncertainty looms with the US election fast approaching.

The downtrend in rates stayed firm despite the volatility experienced over the month. US benchmark interest rates hit a year-to-date low of 3.79% during the early month’s steep sell-off, before rebounding to almost 4% before again continuing a decline to end the month 3.9%, 13 basis points (bps) lower then where it was at the start of August. US Treasury curve flattened further, leaving the 2s-10s just shy of completely reversing its inversion as the 2 year USTs rallied aggressively by 34bps.

JACI Investment Grade (IG) spreads hit year-to-date highs of 155bps before reversing to consolidate at the end of the month at 131bps. Other than the witnessed volatility at the start of the month, the credit tone held up relatively well, with credits trading sideways before picking up some speed in recovery in anticipation of an uptick of new issuances after the first rate cuts are implemented by the Fed.

Credit to July’s non-farm payroll downside surprise, US hard landing concerns, and a hawkish Bank of Japan, credit markets in August opened to c.20bps of spread widening in Asian IG bonds. Luckily, market panic was short-lived as sentiment and bonds valuation recovered fast in the following week. Companies started to announce the semi-annual reports in middle of August. Earnings from the TMT space continued to demonstrate resilience with strong earnings and robust credit metrics. In particular, major BBB rated China technology firms saw solid growth, driven by global mobile phones industry recovery, improving margins and AI-related revenue growth. In the Thailand state owned entities (SOE) space, PTT cited tough market conditions and announced its intent to divest some of its group companies, including PTT Global Chemicals (PTTGC) and Thai Oil (TOPTB). Both bonds saw spreads leaking up to low double digit basis points wider on the back of the news, before retracing some of the spread widening. Spreads of Resorts World Las Vegas increased by up to 20bps as news broke that it was accused of regulatory violations by the Nevada Gaming Control Board’s (NGCB) but recovered to end the month 9bps tighter than the start of August along with the broader market recovery. What remains to be seen will be how these events will affect Genting’s bid for a New York full casino license. Malaysian telco, Axiata, announced the tender of its long end bonds as part of its deleveraging efforts to improve its debt load.

Indonesian quasi-sovereign bonds performed in line with the broader market, both during the early month’s sell-off as well as the subsequent recovery. Spreads of Korean quasisovereigns leaked wider, but total returns remained positive due to the larger rally in rates.

Primary issuance picked up towards the end of the month ahead of the looming rate cuts by the Fed. The Philippines government priced USD2.5bil of issuances as part of its second USD bond offering for the year, while Malaysia’s Khazanah Nasional issued 5- and 10-year tenors of USD bonds amounting to USD1bil.

As history has it, the mechanics of monetary policy transmissions can be opaque and accompanied by varying degrees of time lags. Last year, we underestimated the time it would take for Covid-era financial stimulus to unwind and were arguably early in our views of a slowdown in the US economy. This last mile of disinflation has indeed been bumpy, but our bearish views of a weakening US economy are of late finding resonance in the latest economic data releases. While we may not see inflation fall below 2%, the Fed has lowered the bar required to shifts gears to rate cuts, particularly if other economic data do not throw hawkish surprises to the downward economic momentum.

We maintain our long bias in US interest rate duration with a higher conviction that we have seen the peak in US policy rates. With uncertainties and cracks in economic indicators getting more pronounced over the past year, there is a good possibility that the first cuts could commence by September. Downside risks to our base case include further increases in US treasury issuance, a US debt crisis, and a re-acceleration in inflation, any of which could challenge the team’s long US duration positioning. Should any of these scenarios pan out, the sanguine outlook that markets have priced in for credit spreads could also be at risk. That said, the building election rhetoric and geopolitical events remain wildcards that would warrant a dynamic approach to managing our duration exposures.

The European Central Bank (ECB)’s rate cut was largely within expectations, and the European economy’s outlook is looking less depressed despite subdued growth, with manufacturing coming off its lows and inflation broadly trending lower from lower energy prices. It remains to be seen if the ECB can afford to stagger its cuts in policy rates should consumption falter and inflation remain sticky in the services sector. Added complexities from the global trade war and geopolitics may further hinder EU’s fiscal consolidation plans.

China’s policies have been highly accommodative and recent policy measures aimed at destocking excessive property inventory have seemed to gain positive traction. In undertaking an ambitious growth target of 5% for 2024, allowing a continued budget deficit of 3%, and issuing special treasury bonds, China is sending a strong signal in committing to growth. However, the multilayered problems causing China’s slowdown means that we don’t expect a quick recovery. The property sector and weak consumer sentiment will remain weak links that need to be addressed. In other words, we still need actual consumer confidence and pre-sales numbers in the property sector to pick up on a sustained basis before market confidence can be restored. Nevertheless, we are of the belief that the Chinese economy will emerge much stronger from this consolidation process and maintain a positive long-term outlook for the economy.

Asian economies have been resilient thus far, but effects from China’s slowdown are not negligible. The growth outlook in Asia is showing signs of weakness especially for export-oriented countries including Singapore, South Korea and Taiwan, caused not only by China’s slowdown, but also reflective of the lackluster demand from developed economies. We believe that this trend is likely to stay. Within the Asian region, countries with a stronger domestic story, such as India, are likely to fare better. Against this weakening external backdrop, most Asian central banks have paused rate hikes as inflation moderated and shifted attention to supporting growth. 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.

The Bank of Japan’s (BoJ) exit from its negative interest rate policy (NIRP) and yield-curve control (YCC) policy has not come easy after 7 years in a negative interest rate environment. We expect monetary conditions to remain very accommodative in Japan as the BoJ monitors the long anticipated virtuous cycle — for higher wages to translate into higher spending, for the economy’s ability to sustain inflation at its 2% target. In the meantime, the course of the dollar’s strength remains largely driven by the Fed’s monetary policy. When the first rate cuts are implemented, Asian local currency bonds may perform well, and this will likely lead to further dollar weakness versus Asian currencies, further boosting Asian local bond returns.

While Asian Credit fundamentals have remained stable, demand-supply technicals has been, and will still be, the bigger driver of credit performance in the near term. In line with broad expectations, the scarcity in bond supply has also rendered new issuance premium to be increasingly small. At this juncture, we remain constructive in Asian IG credit as high all-in yields well above 5% does makes this asset class attractive from an income carry perspective. That said, with spread levels at record tights, a risk-off scenario could occur very swiftly at current valuation levels. Our bias is for higher quality names and to ensure sufficient diversification in portfolios as the market rides this rally in credit spreads. We prefer issuers with the liquidity and resilience to withstand a hard global landing, should such a scenario emerge.

Source : Company data, First Sentier Investors, as of 31 August 2024