A monthly review and outlook of the Asian Quality Bond market.
Market review - as at March 2023
The Asian credit market returned +0.90% in March. Credit spreads leaked wider in Asian Investment Grade (IG) credits as the turmoil in US and Europe banking unfolded, while Asian High Yield (HY) bonds almost wiped out its year-to-date rally as Sino-Ocean’s coupon deferral (SINOCE) reignited market volatility. Over the course of the month, Asian IG spreads widened 27basis points (bps) to 195bps, and Asian HY spreads widened by 124bps to 870bps. The ensuing pessimism in economic outlook that followed the banking crisis also caused US Treasury (UST) 10-year yields to decline sharply, even amid the US Federal Reserve’s (Fed) continuation to raise rates by 25bps. The steep rally in rates more than offset the widening of spreads, and that resulted in positive returns for the Asian credit market.
The Asian credit market was not spared from the global risk-off sentiments caused by the Silicon Valley Bank (SVB) fallout early in the month, as well as the write-down of Credit Suisse’s Additional Tier 1 (AT1) securities. AT1 securities from Asian issuers experienced various degrees of selloff, but the spread widening seen amongst Asian credit was relatively contained compared to other markets, thanks to robust technicals and strong intrinsic credit profiles of major banks within the Asian region. While cautious of negative surprises, our findings thus far suggest that Asia would be impacted less by the collapse of three regional banks in the US and the forced sale of Credit Suisse to UBS. We expect Asian AT1s to remain more resilient than their global peers, given the higher likelihood of pre-emptive government liquidity supports for Asian banks compared with European (EU) and US banks as evidenced in previous crises. Amongst major Asian banks, negligible direct exposures to SVB and limited unrealised losses in Held-To-Maturity (HTM) investment books also bode well for weathering the market volatility that has engulfed banks in the US and Europe. In the rest of the Asian IG space, the China reopening story still remains highly supportive towards markets sentiment.
In Asian HY, China property names saw spreads widened on risk-off sentiment that followed the SVB and CS crisis. Panic selling seized the market after a benchmark name, Sino-Ocean (SINOCE), announced deferment of its coupon payment on a perpetual bond amounting to USD 20.6mil. Other privately-owned enterprises (POE) such as Country Garden saw bond prices falling 8-10 points across the curve. Citing the overwhelmingly negative market reaction, SINOCE subsequently repaid the coupon. Towards the end of the month, improved sentiments saw some price rallies amongst HY property bonds, led by Country Garden. Bond prices for SINOCE remain battered, however, as the developer received a qualified opinion from their auditor, who raised questions regarding the company’s ability to continue as a going concern.
Asian sovereign bonds spreads widened following risk-off sentiments. Spreads of investment grade sovereign and quasi-sovereign bonds moved mostly in proportion to USTs, resulting in a mild effect on prices. Meanwhile, high yield sovereign bonds in markets such as Sri Lanka continued to face downward pressure, despite better clarity for bondholders in the country’s debt restructuring with the IMF.
Overall issuance volume fell in March 2023. Issuance from financials experienced a pull back with the market turbulence from developed markets. Nevertheless, in the investment grade space, quality names still came to the market, such as Korea National Oil Corporation, POSCO, Export-Import Bank of Korea, and Sumitomo Corporation still garnering positive responses from investors.
The Fund is posturing for a volatile quarter ahead as it continues to invest cash in quality names with the ability to survive a potential downturn. Purchases were made in attractively priced Indonesian quasi-sovereigns, such as Pertamina and Indofood, as well as longer tenure Chinese technology names such as Alibaba and Tencent, as regulatory pressure eases in the Chinese technology sector.
In the primary market, the Fund participated in Sumitomo Corporation and took profit later in the month as spreads tightened.
On a net-of-fees basis (SGD terms), the First Sentier Asian Quality Bond Fund returned 0.84% in March, underperforming its benchmark by -0.58%.
On a relative basis, the Fund underperformed its benchmark as overweights in Chinese property and Indonesia quasi-sovereign bonds gave up some recent gains. However, the sharp rally in US treasuries over the month offset some of the negative excess returns as the market was gripped by risk-off sentiments from the US and Europe banking crisis.
Q2 2023 investment outlook
Risky assets started the year in euphoria as a moderation in US inflation led the US Fed to switch to a more gradual path of rate hikes. A complete relaxation in China’s zero-Covid policy further boosted market’s sentiment up to a point valuations in credit markets is no longer pricing in any risk of a global recession. While uncertainty around global growth remains, the high all in yield for Asian Credit is an attractive proposition for us to stay constructive in this asset class.
US economy appears resilient of late and labor market remains tight as jobs creation surprised on the upside. Corporate earnings remain decent though outlook is looking increasingly cautious. We are of the view that the stronger than expected headline figures, especially that of the labor market is likely to have veiled the underlying weakness in the US economy. This weakness may have already started during Q4 2022, during which major US technology firms started laying off workers, a clear indication the outlook is not looking too rosy. US imports have also slowed down significantly in recent months, a trend that is highly evident as we simultaneously witnessed sharp decline in Asian exports. With interest rate now at elevated levels, we are starting to see stress in the housing market as many Americans struggle with the high mortgage rate. With consumer prices moving significantly higher, real disposable income has inevitably declined and this will significantly impact consumption going forward even if inflation is to moderate. We believe the US Fed will continue hiking policy rate at 25bps per meeting so long as unemployment rate stays low and economy continues to expand. We also believe it is inconceivable for the Fed to continue tightening without bringing about a recession. In other words, we believe a recession is imminent. The only question is when it will happen and how deep it gets.
Similar to the US, Eurozone economy held up well despite the numerous challenges it faces which include the Russian-Ukraine war. Inflation though remains a serious problem and looks to be much worse than that in the US at this juncture. This means the ECB will likely remain hawkish and play catch-up on policy tightening with the US Fed. Nevertheless, we do take some comfort that the region is now better prepared for further energy shocks as inventory level is high as the region adjusts to a prolonged Russian-Ukraine war. This should help alleviate concerns around a further spike in inflation figures should the war take a turn for the worse.
Meanwhile in Japan, border re-opening since last October didn’t quite help bring about a strong recovery in economic activities. In fact growth momentum is showing signs of slowing as exports declined amid weakening global demand especially those from US and Europe. We are skeptical that China re-opening could give Japan a much needed lift. Despite being stuck in a deflationary spiral over the past three decades, Japan did not welcome the current strong inflationary environment as it is costs led rather than demand driven. The weakening yen has further exacerbated the problem to the point it is affecting consumption. While BOJ recently maintained that they will not tweak monetary policy due to supply side issues, we do think a further widening of the yield curve control could not be totally ruled out. We believe BOJ will continue to curb excessive weakness in the Yen while adopting a gradual change to monetary policy if needed.
Asian credit market continued its strong rally towards the end of 2022 on the back an expectation of a more gradual rate hike by the US Fed coupled with positive sentiment around China’s re-opening. Valuation for investment grade bonds are now tighter than historical average. Nevertheless, we remain positive on the credit fundamentals of Asian IG and we expect little credit rating changes from here. Supply is also likely to remain soft and hence supportive for bond’s demand and supply technical. Should the Fed continue to bring terminal rate higher, the high all in yield of close to 6% would make Asian Investment Grade bonds too attractive to ignore. In other words despite of a cautious global economic outlook, we remain constructive on Asian IG. Asian High Yield led by Chinese properties bonds have done very well of late and is likely to take a pause. We do believe the worse could be over for this sector though we do need to see pre-sales figures improving significantly before bond prices can move higher from here. Following a strong run in the past few months, Asian currencies retraced some of its gain as the dollar regained some ground as market started pricing in a higher terminal Fed fund rate. We do believe this trend may continue a little longer though any further weakness could provide investors a more attractive entry point into Asian currencies. We also expect most Asian central banks to be on hold as inflation figures look relatively benign when compared to developed market peers.
Source : Company data, First Sentier Investors, as of 31 March 2023
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