Asia’s fixed-income markets have been regaining some of their old vigour, as money flows back into emerging market bond funds and issuers put their cash piles to work, reinvigorating the primary market and driving secondary spreads tighter.
The positive feedback loop, which began around the middle of July, mirrored three weeks of positive inflows into emerging market bond funds (to the week ended July 27) and a string of analysts’ reports arguing Asian G3 bonds had become oversold relative to their emerging market and US peers.
However, as August gets under way, fixed-income analysts, bankers and investors remain undecided whether the market has truly bottomed out. Signs that it may have only temporarily rebounded in the absence of negative news headlines have re-asserted themselves over the past few days as the US and China threaten new tariffs, pushing bond spreads wider again.
As Raj Malhotra, head of Asia Pacific debt capital markets at Soc Gen told FinanceAsia: “It’s that age-old conundrum about catching the falling knife.”
Raymond Gui, co-CIO of Asian fixed-income fund manager Income Partners, believes Asia’s fixed-income markets will definitively turn in a more positive direction within the next couple of months, or before year-end at the latest.
He also highlights just how long the 2018 downturn has lasted. Over the past decade, he points to four instances of 5% plus corrections for Asia’s G3 high yield markets.
Each sell-off was short and sharp, most notably the 2011 sell-off, triggered by Europe’s debt crisis and 2013’s taper tantrum. “This downturn lasted over eight months from November until its low point in mid-July, pushing the JACI Non-Investment Grade Blended Index down as much as -5.5% year-to-date,” he commented.
By the end of July, the index had bounced back to -2.72% year to date. Indeed, July represents the best month so far this year for Asian credit.
Markit’s iBoxx USD Asia ex-Japan Index returned 0.8% during the month, trimming the overall year-to-date loss to -1.9%.
Like many of his peers, Hong Kong-based Gui has been sitting on 10% to 20% cash levels since the beginning of the year. But he plans to scale back up gradually over the next two to three months.
“Some of that money was invested in onshore government and policy bank bonds, so we benefited from the rally there,” he explained. “But the industry is coming up to year-end and we’re all conscious that cash does not generate carry and therefore returns. We plan to become more active in September.”
Gui favours some selected Chinese real estate and industrial names, which he believes have been oversold. However, he has not invested in local government financing vehicle (LGVF) credits even after the repricing.
“We’ve stayed away from them because the yield wasn’t attractive enough,” he said. “The sector has been repriced, but is still generally trading above 90%.”
Many fear what would happen to LGFV bond prices if domestic Chinese investors decide to pull back en masse, notwithstanding the government’s announcement that it intends to manage the deleveraging campaign at a reasonable pace.
Around the rest of the region, Gui flags the value offered by certain benchmark BB or B-rated Indonesia credits, which have been hit by the double whammy of emerging market currency concerns and the wider fallout of China’s deleveraging campaign.
For example, benchmark single-B names like Jababeka and Lippo Karawachi are still yielding around 10%. The former’s 6.5% October 2023 bond is trading around 10.3%, while the latter’s 6.75% October 2026 bond is at 11.491% according to S&P Capital IQ data.
Both gained about two points when the market turned in mid-July, but have lost almost half of that over first three trading days of August.
Colin Graham, CIO for multiasset solutions at Eastspring Investments, also likes Indonesia. “We’re positive on rupiah-denominated bonds because the currency has become very cheap,” he told FinanceAsia. “We’ve also noted what a good job the central bank has done raising rates and maintaining its credibility."
ISSUERS REGAIN SOME PRICING ADVANTAGE
Soc Gen’s Malhotra says the resumption of risk-on behaviour has helped the pricing pendulum swing back in favour of some higher rated Asian issuers. Indeed, one of July’s chief trends was the level of issuance from investment grade credits led by Temasek, which returned to the bond markets on July 26 with its first bond in six-years: a $1.35 billion 10-year deal.
The triple-A rated Singaporean group was also joined by a host of Korean investment grade borrowers, which took advantage of pent-up demand for green assets, their country’s credit and favourable movements in the EUR-USD basis swap.
Malhotra said that, for many issuers, it is now cheaper to raise funds in euros at the seven- to 10-year part of the curve and then swap the proceeds back to dollars. “At the beginning of the year, the EUR-USD basis was about -35bp,” he explained. “Today it stands at around -13bp, a level we’ve not seen since 2014.”
Both deals were well received thanks to an ongoing supply/demand mismatch with a growing number of funds scratching around for green assets in Asia’s noticeably slim pipeline.
Eastspring Investments is one fund looking to increase its holdings.
Singapore-based Graham said: “We’re analysing how to embed environmental, social and corporate governance into our investment processes. For example, we’re debating how to compare a company, which already has a good sustainability rating with one, which is making significant improvements.”
SocGen’s Malhotra also argues that sustainable and green bonds play well in volatile markets because investors view them as defensive instruments.
“There’s a perception that green investors don’t trade out of green bonds for portfolio reasons even when markets get choppy,” he said. “That means an issuer’s green bonds can outperform its conventional bonds during periods of volatility.”
CHINA’S DELEVERAGING CAMPAIGN
In the high yield sector, both China’s property companies and the odd LGFV were able to tap the market during late July. Even single-B rated issuers were able to access the market during the week ended July 27, led by Sunac China ($400 million) and Yuzhou Properties ($425 million).
They were able to do so after the Chinese government offered what JP Morgan describes as “temporary relief to system liquidity.” On July 18, it was reported that the People’s Bank of China (PBoC) increased the availability of its medium-term lending facility (MLF) to purchase corporate bonds.
The move helped ease funding pressures in China, where lower rated corporates have found it hard to access the bond markets and other financing channels as the government restructures the shadow banking sector and presses on with its deleveraging campaign.
The government reinforced its message at the end of the month when the Politburu issued a communiqué emphasising the need for balance between deleveraging and support for the real economy.
Yet as HSBC says in a recent research report, “the big picture remains” and a large chunk of demand is being systemically removed from China’s bond markets.
For Income Partner’s Gui, China’s deleveraging campaign has been the biggest risk factor facing Asian high yield bond markets.
“We had a strong sense of the impact from the beginning of the year and increased our cash holdings,” he said. “We also maintained an average credit rating of BB and short duration of less than three years.
“We’re positive that policy makers will control the pace of de-leveraging by periodically injecting some stimulus,” he continued. “But it’s very hard to second-guess when this will happen.”
Gui’s other three risk factors comprise Sino-US trade tensions, US interest rate hikes and the concurrent dollar strength, which may continue hurting emerging market assets.
HSBC believes that the market is still not taking the Fed seriously enough.
In a recent research report, Fred Neumann, the bank’s co-head of Asia economics, wrote: “The dots are still plotting well above where the markets expect them.”
Neumann argues that credit remains an important demand driver for many Asian economies and as funding costs rise they will act as a drag on growth. So far, second quarter earnings are beating expectations.
If renewed trade tensions do not get in the way, this sets the Asian bond market up for a potentially strong September pipeline: one that may well spill over into August if issuers seek to get ahead of the pack.