Stronger US economic growth will push Treasury yields higher during the remaining months of 2014, according to fixed income specialists, and could help to renew interest in Asian local currency debt as investors seek out fatter returns.
With core European yields expected to remain lower for longer as the eurozone recovery wilts, currency speculators continue to search for carry trade opportunities — exploiting yield differentials by borrowing in one currency and investing in another. But carry is not the only game in town.
“Carry considerations remain relevant for Asia bonds, but currency returns have recently become a more dominant component,” Andre de Silva, head of rates research for Asia Pacific at HSBC said, adding that Indonesia and Thailand have led currency gains across emerging market Asia during the past month.
The performance of the Thai baht was particularly noteworthy at 2%, while fixed income returns touched 0.8%, according to HSBC in a recent report. For investors seeking exposure to the Thai currency, the bank said that short-dated debt instruments are more suitable as supply pressure looms in August.
Likewise, Indonesia’s currency returns exceeded fixed income gains by 0.6% after the country’s presidential election came to a peaceful and decisive conclusion, prompting nearly $2 billion of equity and bond inflows in July.
While near-term economic data and events are unlikely to trigger a significant local currency bond rally, the high interest income still makes for a good carry trade, specialists said.
“We have seen continued inflows into Asia’s bonds ... which have helped boost nearly every currency in the regional foreign exchange space,” said Frances Cheung, head of Asian rates strategy at Credit Agricole, in a press briefing held in Hong Kong in July.
Investors are concerned about the health of the markets as the US Federal Reserve is expected to end its monthly bond buying in October this year and to start hiking interest rates in 2015.
However, investors and analysts have been predicting higher rates all year without much success. Fears that rates would climb from 3% at the start of the year did not come true, but interest-rate strategists at Goldman Sachs and JP Morgan are sticking by their hunches and still predict the 10-year yield to rise to 3% by the end of the year from current levels of 2.43%, according to Bloomberg data.
Pockets of opportunity
Higher US Treasury rates do not mean that dollar (or yen or euro) investors will be unable to find higher returns, but such opportunities may require investors to be more selective, according to fixed income analysts.
“Asian emerging market fixed income has provided good returns so far this year,” Elke Schoeppl-Jost, chief investment officer for Asia-Pacific at Deutsche Asset and Wealth Management. “Selectivity will be crucial, however: actors driving the market continue to move from broad macroeconomic and policy concerns to more specific issues.”
Last month, issuers such as Korea’s sovereign note maturing in 2044 and Chinese Overseas Land Investment’s bond expiring in 2042 offered returns of 9.33% and 4.96%, according to Bloomberg.
But the real surprise was the performance of high-yield issuers such as Pertamina’s 2044 note and Fantasia’s 2019 paper, with gains of 7.14% and 6.93% respectively.
The shift to high-yield issuers will continue as a combination of favourable influences reinforce rising confidence, a trend that is likely to continue for the rest of 2014 and possibly out to the first quarter of next year, specialists said. China, India and Indonesia in particular will underpin improving confidence.
“We feel that the Asian credit market, in particular the high-yield, should benefit from diminishing GDP and inflation volatility,” said Dilip Shahani, global head of research for Asia Pacific at HSBC. “The logic is simply that better macro certainties encourage risk-taking behaviour.”
Asian high-yield still offers significant spread over comparable US issuers within the same rating buckets, HSBC noted in a recent report. The Asian premium is even more excessive as investors drop into the single-B rating space.
“This sector has the highest re-rating likelihood as market participants become more confident with the top-down outlook for the Asia region ex-Japan,” Shahani said, adding that investors should continue to focus on lower-rated China high-yield property issuers.
Additionally, further reforms should keep investor sentiment positive towards India, and the same goes for China. One of the areas that could be affected by reforms is bond supply.
The Reserve Bank of India recently provided concessions to local banks to provide infrastructure loans, with one of the requirements being such that loans are funded by long-dated bonds.
“This not only impacts the local bond market, but it also indicates a willingness by the authorities to ease the financing channel for infrastructure spending,” Kenneth Ho, credit analyst at Goldman Sachs said. “We think that more new issuance could create relative value opportunities.”
