Our outlook on Asian local currency bonds
- Moderate slowdown in Asian economies with exports growth lacklustre, industrial production showing mild recovery while domestic consumption is relatively robust.
- Fiscal spending by governments would help to cushion slowdown but broader trend is still slower growth than expectations at the start of the year.
- Unexpected slowdown in H1 by China indicates weakening growth momentum domestically as well as intra-Asia trade growth.
- Inflationary pressures may rise moderately for most economies except larger rise in Indonesia on the back of reduction in fuel subsidies.
- Asian central banks are expected to be on hold after recent rate cuts by Thailand, Korea and lowering of SDA by Philippines. Bank Indonesia is expected to raise rates with higher inflation.
Sovereign bonds - Most Asian central banks will stay on hold in Q3. A tightening bias will emerge for only very few Asean countries as inflationary pressures increase while economic growth recovers.
Present low yield levels across Asian bond markets may rise further with profit taking due to rich valuation and concern of US Fed tapering the bond purchase. Over the medium to longer term, we expect global investors to return to Asia and increase allocation to Asian bonds. This would provide support to Asian bonds as yields rise.
We remain negative on countries such as Indonesia, whose low yields are not reflective of growing policy indecision, rising inflationary expectations with expected reduction in fuel subsidy, growing current account deficit and upcoming 2014 elections.
Generally flat curves of most Asian countries should steepen given rising inflationary risks and rich valuation.
Asian LCY bonds show lower volatilities and better return-to-risk performance than emerging market debts
Asian local currency bonds are composed of developed markets (Singapore, Hong Kong) along with other Asian bond markets that are classified as emerging markets. The Markit iBoxx ABF Pan-Asia Bond Index has about 30.5% allocation to Hong Kong and Singapore. This combination of both developed and emerging markets provides diversification in Asian local currency bonds leading to relatively lower volatilities compared to emerging market debt.
The chart bellows shows the rolling 1-year volatility of Asian local currency bonds vs. that of Emerging Market local currency bonds. It shows the relatively lower volatilities for Asian bonds.
With concerns on the US Fed quantitative easing taper, emerging market bonds/currencies have sold off more than developed markets. This has resulted to overall emerging markets having more negative performance than Asian local currency bonds in the current selloff. Performance year-to-date (up to Aug 19) for the Barclays Capital EM Local Currency Government Bond Index was at -3.18% (in USD) while the Markit iBoxx ABF Pan-Asia Bond Index was at -2.43% (in USD) for the same period.
The Chinese economic slowdown may affect Asian bonds in the short-term, but it is a much needed structural adjustment that would benefit the whole region in the long run.
Chinese economic slowdown would in general mean that interest rates in China would stay low and bonds well supported. At the same time, renminbi appreciation pace may slow down. The ripple effect of Chinese economic slowdown to the rest of Asia would be Asian ex-China exports would grow at a lower rate. This would necessitate Asian countries to give more emphasis to strengthening domestic demand. Asian bond yields may also trend lower with slower Asian economic growth leading to accommodative monetary policy stance by the central banks. In the short-term, there may be investors concern of the Asian slowdown and reduce exposures to Asian bonds as currencies weaken.
However, in the long-term, Chinese economic slowdown is a structural adjustment that is necessary for sustainability and its economic rebalancing towards consumption rather than exports. This adjustment if successfully carried out would be positive for Asian economies as a steady large core Asian economy such as China with rising domestic consumption would further deepen intra-Asia trade and capital flows. The rest of Asia would benefit from this, with economic fundamentals and resilience further enhanced. This would bode well for Asian local currency bonds in the long run.
A diversified Asian bonds instrument such as ABF Pan Asia Bond Index Fund (PAIF) provides diversified exposure to both developed and developing markets.
Higher interest rates from the wind down of the US Fed’s quantitative easing and then subsequent higher policy rates would be negative for fixed income in general. Volatilities are still expected given the rising yields and its impact on emerging markets.
As higher yields become attractive, investors with core allocation in Asian bonds may start investing in Asian bonds again. The sound fundamentals of Asia in general will be supportive for Asian bonds over the medium to long term.
There is some risk to the downside in some Asian countries particularly those with higher current account deficits like Indonesia or higher fiscal deficits like Malaysia. These countries may underperform. Given the diversity in Asian bond markets, their negative impact can be offset by the performance in developed economies and in economies with better economic fundamentals.
Disclaimer This document is issued by State Street Global Advisors Singapore Limited (Company Registration Number (Singapore): 200002719D) and has not been reviewed by the Securities and Futures Commission of Hong Kong ("SFC"). Nothing contained here constitutes investment advice or should be relied on as such.
The past performance of PAIF is not necessarily indicative of its future performance. The prospectus for PAIF is available and may be obtained from State Street Global Advisors Singapore Limited (the "Manager") and authorized participants. The value of PAIF and the income from them, if any, may fall or rise. The semi-annual distributions are dependent on PAIF's performance and are not guaranteed. Redemption of PAIF's units could only be executed in substantial size through designated dealers and the listing of PAIF on the Stock Exchange of Hong Kong ("SEHK") does not guarantee a liquid market for the units, and PAIF may be delisted from the SEHK. PAIF may use or invest in financial derivatives.The Markit iBoxx ABF Pan-Asia Index referenced herein is the property of Markit Indices Limited and is used under license. The PAIF is not sponsored, endorsed, or promoted by Markit Indices Limited or any of its members.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSgA's express written consent.
Important information The views expressed in this material are the views of SSgA Asia Fixed Income team through the period ended 23 August 2013 and are subject to change based on market and other conditions. This document may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that SSgA expects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on certain assumptions and analyses made by SSgA in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which are beyond SSgA’s control. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.This material is for your private information. The information we provide does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. We encourage you to consult your tax or financial advisor. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is no guarantee of future results. All data is sourced from State Street Global Advisors Limited unless otherwise stated. Investing involves risk, including the loss of principal.Although bonds generally present less short-term risk and volatility risk than stocks, bonds contain interest rate risks; the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.