Outlook 2015: Asian bonds
Not too hot and not too cold. ‘Goldilocks growth’ looks set to drive Asian bonds and currencies.
2 December 2014
A slow, drawn-out global recovery with low commodity prices and inflation should continue to be positive for Asia. As a region with strong domestic growth, Asia remains a beneficiary from easy global monetary policies. Both subdued growth and benign inflation in developed markets are likely to keep bond yields low, pushing investors to seek out higher-yielding assets. However, exporters need some buoyancy from their markets so Asian countries will be expected to benefit as better growth in the US, Europe and Japan materialises in 2015.
In a world dominated by weakening demographics, excess savings and insufficient demand, emerging countries in Asia could offer higher potential returns on investment.
As a voracious user of energy to power growth, lower oil prices will be a strong positive for Asia. To produce each unit of GDP, the region will need energy to power its vital manufacturing base and get its goods to developed markets. With a dearth of their own resources compared to other emerging markets, most Asian countries are in fact large energy importers. Therefore, the slump in oil prices will cut trade deficits, limit inflation and, in a region which still favours subsidies for fuel and fertilizer use, also translate into lower fiscal deficits. All this means that central banks in the region are unlikely to increase policy rates as inflation continues to ease, thereby supporting Asian bonds.
Asia still attractive on structural basis
In a world dominated by weakening demographics, excess savings and insufficient demand, emerging countries in Asia could offer higher potential returns on investment. One of the main concerns in Europe, Japan and parts of developed Asia is the contraction of structural demand due to an ageing population. In stagnant or shrinking economies, companies will be more hesitant to invest but population growth is still largely positive in emerging markets. A rising middle class and a booming younger generation of consumers encourages more investment as companies have a brighter long-term outlook on growth. This is in stark contrast to certain developed markets, where ageing populations need the higher returns from investment to pay for their retiring workers.
Both cyclical and structural factors are positive for global investment in Asia, albeit with headwinds that can impact the timing of interest. When US Federal Reserve (Fed) interest rate rises eventually start, there is the risk that the US dollar appreciates and attracts capital flows back to the US. The current widespread belief is that the Fed will make its first move between June and October. Yet low inflation and a tepid recovery will keep it cautious in the timing of its exit and the speed of the policy rate normalisation. Yet some Asian countries have already preempted this move. India and Indonesia have acted to tighten monetary and fiscal policies ahead of any rate rise. Meanwhile other countries (Hong Kong and Singapore), which have been unable to hike rates due to their monetary policy links with the US, would benefit from additional policy flexibility.
Headwinds and opportunities
Another potential hurdle for the region is the weaker Japanese yen. This has weighed on the currencies of countries which compete with the Japanese export juggernaut. Particularly hard hit have been Korea and Taiwan, both of which have expressed concern and seen their currencies weaken. However, our view is that the yen is now very cheap on a number of fundamental currency valuation measures. The strength of Korean trade surpluses shows that Korean exporters remain very competitive.
Furthermore, accommodative central banks and gradual growth should support Asian corporate bonds. While issuance has been strong, Asian corporates offer a substantial yield advantage to similarly-rated issuers in Europe and the US. This combination of moderate growth and low inflation should keep default rates in check in the region. As mentioned above, this all points to a broadly supportive environment for Asian bonds and currencies. Bonds can provide an astute diversifier to equities, and yields from Asian bonds continue to be significantly higher than those in developed markets.
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