A monthly review and outlook of the Asian Quality Bond market.
Market review - as at December 2022
The Asian credit market recorded a second consecutive month of positive returns in December, returning 1.66% as spreads tightened, even as US Treasury (USTs) yields sold off by rising 27 basis points (bps) higher. Despite signs of inflation easing in November’s print, the consistently tight US labour market diverted market concerns on recession back to the US Federal Reserve’s (Fed) path of monetary tightening. China’s continued easing of Covid restrictions was positive for Asian credit spreads, as did further policy easing on China’s property sector.
Asian Investment Grade (IG) spreads tightened by 22bps to 180bps. Asian Credit portfolios took advantage of the positive credit momentum and increased credit risk exposures, though maintaining a bias for higher quality names on heightened recession risk.
In Asian Investment Grade (IG) credits, further relaxation of China’s zero-Covid policy buoyed market sentiments as the Republic announced the removal of quarantine requirements for travelers from early January 2023. China’s Central Economic Work Conference (CEWC) held in the middle of December 2022 also set a positive tone for prioritising economic growth in 2023. Policy agenda included plans to prevent and resolve risks among high quality property developers, which in our view may include developers that recently received strong policy support, such as Vanke, Longfor, Country Garden and Seazen Holdings. We anticipate more demand focused policies to stimulate recovery for the sector. The conference also suggested more support to encourage the growth of private internet platform companies for the betterment of China’s overall economy. We believe that the political and operational environment for internet platform companies in China may improve in 2023. Across the board, Asian IG spreads tightened on overall market optimism, despite lingering concerns on the spike of Covid cases in China.
Sovereign bonds spreads continued to find good support amid market optimism. Broader emerging market (EM) bonds enjoyed positive inflows towards the end of the month. Indonesian, the Philippines and Malaysian sovereign bond prices rallied, as did their quasi-sovereign counterparts such as Pertamina, Perusahaan Listrik Negara (PLN), and Petronas. Relative valuation for IG sovereign bonds continued to tighten over the month, but Indonesia quasi-sovereign bonds such as PLN and Indonesia Asahan Aluminum (IDASAL) continued to offer attractive spreads.
As markets entered year-end, issuance volume in the Asia’s primary market was subdued.
The Fund rode on the market’s positive momentum over the month by adding credit duration, purchasing issuers that were still attractively priced. The Fund added Indofood and PLN, but sold Indonesian sovereign bonds as valuations began to look stretched.
On a net-of-fees basis (SGD terms), the First Sentier Asian Quality Bond Fund returned 1.83% in December, outperforming its benchmark by 1.02%
The positive returns was largely due to the tightening of credit spreads, with exposure to Chinese property names being the main contributor to returns.
Q1 2023 investment outlook
The three key themes driving the Asian credit market’s performance this year have been the US Federal Reserve’s tightening monetary conditions amid record high inflation, negative sentiments towards China especially its zero-Covid policies and global recession concerns. While we expect these factors to continue driving market sentiment as we move into 2023, their impact on market’s performance is likely to be more subdued. The Asian credit market is set to record its first double-digit loss since the Global Financial Crisis. Nevertheless, at a low double-digit negative return, it compares favorably to the high-teens loss in global bonds, as well as the 20% loss seen in emerging market debt. At an all in yield of close to 6% as compared to a historical average of 4%, Asian Investment Grade bonds are looking very attractive especially for long-term investors. While credit spreads may still widen should we get a deep global recession, the high US Treasury yields by historical standards do provide sufficient buffer against the risk of widening credit spreads. With stable debt ratios and still healthy cash balances, we believe that the solid fundamentals in Asian Investment Grade corporates will help the asset class remain resilient through a downturn.
In the near term, we expect the US Fed to continue hiking policy rate towards the 5.00-5.25% range as long as unemployment stays low. While prices can still be rising, the rate of increase is likely to slow given the high base effect. We are of the opinion that we may have seen the peak in inflation and thus market’s expectation of the terminal fed fund rate should not move higher from here. There have been signs of a slowdown in economic growth in the US as evidenced in the housing market, lay-offs in the technology sector and a sluggish semi-conductor industry. This could possibly explain why the US yield curve has inverted quite sharply of late, as long-term rates are pricing in heightened uncertainty. However, we deem any talks of rate cuts to be premature at this juncture.
Post President Xi’s consolidation of power at the 20th National Congress of the Chinese Communist Party (CCP), we have observed positive policy developments in China which suggest that the nation could move more swiftly to address its weak economic growth with a focus on infrastructure spending. Policy measures to help the ailing Chinese property sector have been trickling in since the early part of the year but saw a meaningful pickup in November 2022, both in terms of policy line-up and financial firepower. We are hopeful that the China’s relaxation of its zero-Covid policy will be steady and incremental. Downside risk remains with weak primary sales in the property sector. For a sector that has been undergoing such a prolonged policy induced liquidity crisis, primary market sales recovery remains crucial for the longer-term survival of some private developers before we can assume the worst is over for the Chinese property sector. Until we see strong evidence of primary market sales recovery, property bonds will likely remain volatile, with price swings vacillating between policy optimism and fragile fundamentals.
We expect the Bank of Japan (BOJ) to maintain the Yield Curve Control (YCC) program at least until the end of Kuroda’s term in April 2023. Japan’s recent border reopening may spur a short-lived bounce in growth data. However, poor wage growth and weak consumption remains deeply entrenched challenges in an economy that is now feeling the effects of cost-push inflation. We do not rule out the possibilities of adjustments to the current YCC program, though with ample reserves at hand, the BOJ is likely to intervene in the foreign exchange (FX) market should we get another bout of yen weakness instead. In other words, the BOJ could still seek to keep Japanese Government Bond (JGB) yields stable for the medium term.
The strength of the greenback witnessed in 2022 is starting to show signs of waning. We see higher certainty of the Euro and other Asian currencies appreciating against the US dollar, as the European Central Bank is further behind in completing its policy tightening measures. Select Asian currencies with relatively benign inflation and lower interest rates as compared to developed markets, could see further upside from China’s reopening measures as economic activity picks-up in the region.
Investors remain worried of the prospects of an economic recession. Food and energy supply chains disruptions could further deepen in certain economies in Europe and the UK, particularly against a backdrop where real disposable incomes have been falling for the most part of 2022. Geopolitical concerns — the protracted Russia-Ukraine war and simmering US-China trade tensions, remain threats that could thrust the world into a deep recession and sustain the dollar’s strength, and these concerns could feature more strongly in 2023.
Source : Company data, First Sentier Investors, as of 31 December 2022
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