Asia’s G3 bond markets got off to a better start in January than even the biggest bulls predicted a month ago, but bankers and fund managers warn that it is unlikely to last.
Market participants attribute strong primary market demand and secondary market tightening almost entirely to the US Federal Reserve’s end-of-year decision to become more “data-dependent” and “patient” regarding interest rate hikes. Lower rates keep Asia stronger.
Sean McNelis, HSBC’s
co-head of Asia-Pacific debt capital markets, sums up the prevailing optimistic view when he says: “Lower US rate expectations have helped Asian bond markets more than any other region”.
He told FinanceAsia: “The region is always more sensitive to sudden changes in Fed policy. It’s one of the main reasons why issuance and investor receptivity has been stronger in this part of the world so far this year.”
On the surface it does not seem that way where issuance is concerned. Levels are roughly one-third below January 2018’s record-breaking base.
But that drop masks the strength of demand for the deals, which have come. That, in turn, has prompted investment banks to scale new issue premiums right back.
Typical is the experience of China Greentown Holdings.
On January 25, the Ba3/BB- credit amassed a $5.6 billion order book for a $400 million perpetual non-call three-year deal. The offering not only re-opened the market for corporate hybrids, but investors’ enthusiasm also gave the issuer the confidence to fix the coupon at 8.125%, some 50bp tighter than initial guidance around the 8.625% level.
However, debt capital markets bankers have been encouraging issuers to get ahead of a possible about-turn by accessing the market sooner rather than later.
McNelis says issuers also agree. “The market has momentum but not necessarily longer-term conviction," he said. "Both the buy side and sell side are aware that 2019 could still be volatile.
“Having said that, we’re more optimistic than the street. We think 2019 will be stronger than 2018 and we're already seeing that with the types of deals and subscription levels in January.”
Fund managers back up this view.
Ricky Tang, Schroders
Ricky Tang, Schroders
' deputy head of multi-asset products for North Asia, told FinanceAsia
: “We think this is just a short-term rebound. The momentum could slow once the markets realise that the Fed needs to be a bit more hawkish than consensus expectations because growth hasn't slowed that much.”
Tang highlights how market expectations about US interest rate movements have been all over the place in recent months.
Back in September, the consensus was for two to three hikes in 2019. At beginning of the year, it was down to none, before swinging back to one again over the past couple of weeks.
current house view is also for one hike. Stephen Chang, Hong Kong-based portfolio manager for Asia, told FinanceAsia
that this helped him to become a lot more positive in December, particularly about Asian high yield.
“There’s been more supply than we thought this January, but the market’s been taking it in its stride,” he said. “We still think Chinese high yield valuations are looking attractive in many cases even after the recent rally.”
At the end of January, for example, the Bloomberg Asia High Yield Index stood at 7.88%, 107bp tighter than the beginning of the year. It has been an incredibly strong performance, even stronger than the Bloomberg US High Yield Index, which is in 92bp over the same period.
Stephen Chang, Pimco
Chang, however, believes that secondary market performance has still been slightly out of sync with primary market oversubscription levels because investors have piled into the new deals first to benefit from their new-issue premiums.
“There’s always a bit of a lagging effect,” Chang said. “But secondary markets will catch up if the rally continues.”
Other positive factors include Chinese institutions' higher investment quotas and a willingness in building up in positions among the dealer community.
And then there are the private banking investors who have been almost completely absent since Asian bond spreads hit record tight levels in 2017.
“Most market participants have been surprised by how strongly PB demand has come back,” McNelis said. “They’re feeling better about the markets, but they’re only investing where they see real value and attractive yields.”
USING UP QUOTAS
For dollar-denominated issuers, January was all about using up last year’s NDRC quotas, which had to be extended into 2019 because markets were all but closed during the last three months of the year.
Investment bankers expect issuance patterns to change after Chinese New Year when new quotas come into force.
They believe there will slightly less activity given how many companies will be in blackout periods for their first quarter results. They also expect more investment grade offerings, noting that several Hong Kong corporates have re-financing requirements.
January’s most significant deal was arguably not a dollar-denominated transaction at all, but Bank of China’s
landmark Rmb40 billion ($5.9 billion) perpetual non-call five-year bond. The offering has not only paved the way for unlisted Chinese banks to bolster their Common Equity Tier 1 capital, but also provided international investors with their first high yield Rmb-denominated offering through Bond Connect.
One of 2019’s defining trends is fast shaping up to be foreign investors’ appetite for Chinese bank capital, Rmb-denominated bonds, or both at the same time. It is going to be a year when Chinese banks begin raising hundreds of billions of dollars of bank capital and foreign investors potentially invest almost as much in China’s onshore bond markets as Chinese Government Bonds (CGBs) gain index inclusion.
Schroders Tang and Pimco’s Chang both see value in CGBs thanks to the Chinese government’s easing bias. But like all of their peers, they have yet to venture further down the credit spectrum beyond policy bank bonds.
This is partly down to tax since corporate bonds attract 15% withholding taxes whereas CGBs and policy bank bonds do not.
Perhaps more surprisingly, fund managers seem less worried about corporate defaults.
“We’re comfortable with the current situation,” Tang said. “Defaults may tick up, but it’s clear that the government wants to support the economy.”
Chang agrees and believes the government will try to underpin growth through tax cuts and infrastructure spending, adding: “However this time, the government will be much more targeted in its approach so the money goes where it’s needed.”
During 2018, India and Indonesia were among Asia’s worst secondary market performers thanks to the strong dollar, which prompted outflows from emerging market bond funds, local currency depreciation and bond spread widening across the board.
India also had a quiet year in the primary markets, but has come back strongly in 2019, as borrowers try to get ahead of political uncertainty surrounding parliamentary elections to the Lok Sabha in May.
But Pimco’s Chang says he is more cautious about India: “The stock of non-performing loans is high and this could prompt slower growth.”
He has a much more constructive view on Indonesia, where the central bank has been preemptively hiking rates ahead of the Fed. The country also has a presidential election in April, but Chang says he plans to buy into any electoral volatility because he likes the economic fundamentals.
A more benign dollar environment is already feeding down into the lower end of the Indonesian credit spectrum. Last year, weaker credits were hit by concerns that they were either not fully hedged, or their hedges had been knocked out by a stronger-than-expected dollar.
This year, they have been among the region’s best performers. Tyre-maker Gajah Tunggal’s
8.375% August 2022 bond, for instance, has snapped back 231bp since the beginning of the year to 11.921%.
This double-digit level is still not a very enticing proposition for would-be borrowers, but it is welcome news for fund managers hoping to put 2018 behind them.
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