A monthly review and outlook of the Asian Quality Bond market.
Market review - as at August 2022
The Asian credit market returned -0.8% in August, weighed down primarily by higher US Treasury yields, although this was offset by tightening credit spreads. Hawkish Fed sentiments drove yields higher despite improvements in the credit market, which saw 3 consecutive weeks of investment inflows. Despite weak economic data and high inflation prints clouding the economic outlook in Asia, Asian Investment Grade (IG) spreads tightened by 34 basis points (bps) to 199bps, while Asian High Yield (HY) spreads tightened by 55bps to 1013bps. We continue to be selective in credits that are able to survive stressed market conditions.
In Asian IG, China credit outperformed the broader index, buoyed by positive sentiments from support measures by the Chinese government. China’s state council announced stimulus package for various sectors and also urged local governments to support housing demand. In a move to stabilise the property market, the People’s Bank of China (PBoC) also cut the 5-year Loan Prime Rate (LPR) to 4.3%. Despite improving sentiments and valuation over the month of August, downside risks from the country’s zero-Covid policy features prominently as part of China’s macro backdrop. In the tech sector, positive headlines emerged as China and the US reached a preliminary agreement for the US to review audit documents of Chinese businesses listed in the US.
EM sovereign bonds traded strongly with the asset class witnessing a 3-week streak of inflows over the month. Spreads rallied strongly in the sovereign and quasi-sovereign space. We still maintain our view that IG-rated sovereigns remain in a relatively better position relative to frontier markets from a fundamental standpoint.
Overall volume in the Asia primary issuance market remained subdued as the risk-off tone and rate volatility dampened issuers’ appetite.
The portfolio added to credit spreads as we purchased credits such as China Resources, Haohua, CNPC, and Sinopec. We also sold China government bonds on the view that there was limited upside to yields, and took profit on names where valuation was no longer attractive (Exim India and Power Finance). We also trimmed exposures in China asset management companies (Huarong and Greatwall).
On a net-of-fees basis (SGD terms), the First Sentier Asian Quality Bond Fund returned -0.25% in August, outperforming its benchmark by 0.57%.
The positive return was largely due to the tightening of credit spreads as risk sentiments improved. Positive news in the Chinese property market added to returns, as did the portfolio’s neutral positioning in US rates.
Q4 2022 investment outlook
Notwithstanding the ongoing rate hike cycle by the Fed, our expectations of a rally in the long end of US Treasuries did materialise as recessionary fears increased; the 10 year US Treasury yield briefly descended 90bps from its peak in June on heightened recessionary fears. At this juncture, we expect the Fed to stay its course in upcoming meetings, hiking rates to curb inflation on the premise that unemployment rate stays low and economic activities do not contract too sharply. Our recalibrated view is to turn more cautious on US duration though we see any further sell-off as opportunities to accumulate long positions.
Meanwhile, the inflation situation in Europe is much more precarious. Despite oil price correcting more than 20% below its recent peak, Eurozone inflation is likely to remain elevated even as the inflation expectations in the US moderate. With the Eurozone’s higher dependence on natural gas, inflationary pressures will continue to rise amid the ongoing Russia-Ukraine war and as insulation heating demands rise in winter. It is getting harder to fathom how Europe can sustain significantly lower interest rates versus the US, amid a much higher inflation that is seeing no reprieve. The continued weakness of the Euro also compounds the inflationary problems currently faced by the region. While the European Central Bank (ECB) is widely expected to drag its feet in delivering rate hikes, a convergence in monetary policy between the ECB and the Fed cannot be totally ruled out and that could potentially lead to increased volatility for risky assets.
Along with other developed markets, Japan’s inflation has been rising as well, albeit at a much slower and a more measured pace, allowing the Bank of Japan (BOJ) to remain highly accommodative with their monetary policy stance. That said, the recent weakness of the JPY where it reached a 25-year low has started to cause alarm across markets. We believe the BOJ will likely intervene if JPY weakness persists. However, if there is no change in monetary policy by the BOJ while the Fed continues to hike, we are unlikely to see an immediate turnaround for JPY.
Sentiments in Asian credit have been dominated by Fed rate hike expectations this year and we expect that to continue for the rest of 2022. In the months ahead, we will be closely watching China’s developments particularly around the mid-October 20th Party Congress. A relaxation in China’s zero-Covid policy stance post the congress meeting would boost market sentiments immensely and help China’s property sector through improving pre-sale numbers. Recent developments, such as the liquidity fund for distressed developers, have been positive. We believe that the Chinese government will do everything they can to provide access to onshore funding for many of the property developers.
Based on 1H22 earnings, Asian investment grade (IG) credit fundamentals have remained sound. A large majority of Asian companies (ex-China) reported strong revenue and earnings before interest, taxes, depreciation, and amortisation (EBITDA) growth along with margin improvements, resulting in lower gearing and leverage ratios. In line with market expectations, pockets of weakness were observed within China, as property names and China AMCs saw earnings decline amid the country’s property market crisis. The chinese technology sector also experienced decline in revenue and EBITDA margins although credit profiles remain stable. In contrast, oil majors in China and the rest of Asia posted very strong earnings while capex projections remain largely within expectations. We see the strong credit rally in August bringing Asian IG back into fair valued territory, as it spreads in the JPM Asia Credit Index (JACI) hover back to its 5-year average. Nonetheless, an all-in yield for JACI IG at close 5% looks highly attractive for longer-term investors.
Amid the Fed’s aggressive rate hike cycle, the US dollar has continued to surge higher and has now breached key resistance levels vs other developed market currencies (eg: EUR and JPY). This has in turn led to pronounced weakness in Asian currencies. While the MYR and KRW are now trading at very attractive levels, we prefer to observe the USD strength on the sidelines until signs of a significant shift in policy stance from the ECB and BOJ emerge. In fact, the greenback may even strengthen in the event of a global recession next year. In local currency bonds, bond yields in most markets, with the exception of China, have been edging higher due to higher inflation and rate hike expectations. While Asia’s inflation numbers pale in comparison to those in the US and Europe, a global recession could trigger outflows in local currency bonds. We advocate caution in adding exposures to these markets for now.
Source : Company data, First Sentier Investors, as of 31 August 2022
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