A monthly review and outlook of the Asian Quality Bond market.
Market review - as at September 2017
The tone in Asian credit market was firm during the month of September as concerns over geo-political tension in North Korea waned despite Kim Jong Un’s unrelenting resolve to continue missiles testing. Both ECB and Fed were notably more hawkish despite keeping policy rates unchanged as they discussed reduction of bond purchases, which pushed US treasuries and Bunds yield higher. There is also renewed optimism over Trump delivering tax cuts or reforms further exacerbating the upward move in bond yields. With the positive sentiments in credit being negated by higher interest rates, JACI ended the month little changed at -0.01%. Investment grade returned a -0.16%, underperforming high yield which continued to deliver positive returns of 0.51% for the month.
By country, spread returns were all positive except for South Korea (-0.12%) as investors shunned Korean papers amid the geo-political uncertainty despite spreads having widened by 20-30bps in recent months. Notwithstanding the tight valuations, EM markets sovereign continue to do well with Indonesia, Pakistan and Vietnam leading the pack when ranked by spread returns.
While the European Central Bank (ECB) left its QE program unchanged as widely expected, Draghi said in the press conference that they discussed the pros and cons of various QE scenarios and tasked committees to continue working on them. He indicated that the bulk of QE decisions will be taken in October. Nevertheless, he stressed that not all relevant information may be available by the late-October meeting and if so, the decision on the asset purchase program may have to be postponed until mid-December, right before the program ends. Meanwhile, the US Fed left policy rate unchanged and confirmed reinvestment tapering will begin in October. It will start with a reduction in purchase of $10bn in October, followed by a $20bn reduction in January and subsequently increasing the amount reduced by $10bn every consecutive quarter till it reaches a maximum of $50bn. Barring negative surprises, Yellen said the Fed is on track to raise rates one more time this year and still expects three hikes in 2018. While she recognizes that inflation has been below their target of late, she is confident that labor market tightness will eventually push inflation up and the Fed wants to avoid having to tighten policy aggressively to deal with an inflation problem and thereby cause a recession. The current low level of inflation allows the Fed to move relatively slowly and cautiously.
During the month, we continued to see tensions heightening between the US and North Korea though that is largely brushed aside by the resilient markets. There were several political developments all of which have muted effect on the markets. Japan’s Prime Minister Abe dissolved the lower house of parliament and called for a snap election while Angel Merkel’s party came in first in the German national election, assuring her of a fourth term as chancellor.
On rating actions, S&P cut China’s sovereign credit rating for the first time since 1999, citing the risks from soaring debt and revised its outlook to stable from negative. The sovereign rating was cut by one notch to A+ from AA-. S&P said China’s prolonged period of strong credit growth has increased its economic and financial risks. They added that although this credit growth had contributed to strong real gross domestic product growth and higher asset prices, it has also diminished financial stability to some extent.
New issuance remained robust at USD 28.4b most of which were investment grade and bank capitals. China accounts for 68% of total issuance followed by Hong Kong at 16%. Year to date supply is now 54% higher than the same period last year.
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