Asia IG: a defensive asset class

Asia’s debt market pipeline has come to a standstill thanks to recent market volatility, but the investment-grade sector is still likely to provide some upside.

An accumulation of adverse news last week sent jitters across Asian debt capital markets, shutting off the pipeline of new issues, at least temporarily, but is unlikely to hold down the region’s investment-grade sector for long.

Credit spreads in Asia widened after the Swiss National Bank wrong footed markets and sent the Swiss franc soaring, oil prices continued to fall, Chinese property concerns nagged in the wake of Kaisa's loan default, and US Treasury yields tightened as investors rushed to safe-haven assets.

There was no dollar-, euro- or yen-denominated bond-raising activity at all from Asian issuers on Friday and Monday, which is unusual for January — a month that usually sees a flood of debt deals.

“Volatility in the Asia credit market remained high over the past week as sentiment towards risky assets remained weak with further oil price weakness and 10-year [US Treasuries] dropping to 1.73%,” said Kenneth Ho, credit analyst at Goldman Sachs. “Idiosyncratic risk remains high, as investors are concerned that there will be other China property developers following a similar fate to Kaisa.”

According to EPFR Global, a fund flows and asset allocation data provider, money has continued to flow out of Emerging Markets Bond Funds with redemptions hitting hard currency EM Funds three times as hard as their local currency counterparts.

And as some investors pulled put, so prices have fallen. The Asia iTraxx investment-grade index closed with a yield of 122 basis points on Friday, 5 basis points wider compared to the week before. Other investment-grade credits traded around 5bp to 7bp wider. Woori's new 5.5-year note, for example, lost most of its gains after trading as much as 7bp tighter on Thursday.

But the sector recovered some of its poise on Monday and there are reasons to believe that Asia's investment-grade bonds will continue to thrive in the medium- to long-term, according to credit analysts.

“Over the coming months Asia investment-grade credit may increasingly be a very defensive asset class,” Viktor Hjort, credit analyst at Morgan Stanley, said. “Two changes are under way: large corporates are starting to deleverage and domestic funding conditions are starting to improve.”

If, indeed, corporates are able to cut back on debt in the months ahead it will likely be a highly unusual deleveraging cycle, Hjort said.

Most of the time deleveraging is the result of an improving denominator, such as cash flows recovering as economic growth recovers. But that’s unlikely to be the case for Asia this year — Morgan Stanley forecasts another year of 6% regional GDP growth and a moderately lower 7% growth rate in China.

Instead, the balance sheet improvement is seen coming as a result of lower spending on the back of capital expenditure budgets, which are now being adjusted to a lower return environment.

As for broader credit conditions, Asia will likely see widespread interest rate cuts this year. Economists at Morgan Stanley are forecasting rate cuts in 2015 for China (twice), India (further cuts totaling 125bp after the 25bp cut on January 15) and South Korea (once) — three critical markets. This should reduce local currency real interest rates, making it conducive for issuers to raise funding. 

Looming risks

Switzerland’s central bank shocked economists and markets alike on January 15 when it announced the abandonment of its floor for the euro against the Swiss franc, sending the Swiss currency soaring by as much as 41% at one point. The SNB's minimum exchange rate target — 1.20 Swiss francs for every euro — was introduced in 2011 to stymie capital flows out of the eurozone in the wake of the eurozone sovereign debt crisis.

“This should make us wary of market dislocation as someone picking up nickels gets hit by the proverbial steamroller,” said Mark Tinker, head of AXA Framlington Asia in a note on Monday. “Now might be the time to flatten a few momentum trades.”

The fear is that a lot of financial products made incorrect assumptions about the Swiss peg and about the low volatility of foreign exchange in general, Tinker said. Falling currencies and concerns over dislocation will keep investors on the sidelines for now.

There was more bad news on the Chinese property front after state-owned enterprise China Overseas Land and Investment had 2,800 units of its property blocked for sale by the Shenzhen government on Thursday.

The company later then clarified that the apartments had already been sold and that the temporary suspension was due to a normal administrative measure, not any wrongdoing on its part.

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