Uncovering the value of Asian bonds as the US nears the end of its rate hike cycle
Since the beginning of 2023, the global bond market has experienced significant volatility, especially in the second quarter amidst concerns around the US regional banks crisis and the US debt ceiling. Asian bond spreads widened as global market volatility increased, but overall they remained relatively stable. Returns on Asian credit have risen by nearly 2.5% year to date (as of 30 May 2023).
In 2023, the rebound of the Chinese economy drove Asia credit performance. China’s economy grew 4.5% in the first quarter of the year, which was better than market expectations. Economic data from April 2023 showed that the recovery was driven by the services sector. Food and beverage, tourism, transport and consumer industries performed well. Prospects have been bright for sectors that have been supported by government policy, such as new energy vehicles (EVs), solar energy cells, and advanced technology, but recovery in manufacturing and real estate has been relatively slower. These are areas that the investment markets need to keep an eye on.
We believe that the present benchmark interest rate in mainland China is in line with the current economic situation. Targeted fiscal stimulus measures are needed to further boost economic growth. If China's economic outlook continues to improve, that could potentially have a knock-on effect on neighbouring Asian markets, which could provide desirable returns for Asian bond investors.
In addition to benefiting from Asia’s economic fundamentals, the potential end of the US interest rate hike cycle could attract investors in other regions to Asian bonds, which would further benefit the asset class.
US dollar moderation could spell opportunities in non-US dollar-denominated bonds
From a macro perspective, expectations of the US economy falling into recession and the end of US rate hike cycle means the continued strengthening of the US dollar may come to a pause. This would present an opportunity for other currencies to strengthen and enhance the appeal of non-US dollar-denominated Asian bonds, and further attract capital to the asset class. Bond prices would then rise, potentially bringing about capital gains.
Financial status of Asian regional banks remains strong
From a credit perspective, the uneven pace of recovery across various sectors in Asia means that selecting high-quality bonds is crucial. Within the Asian credit market, the banking sector is expected to perform well given the stability of credit fundamentals and financial conditions. The likelihood of banks in the region collapsing similarly to the US regional banks is low, which is largely a reflection on how Asian banks are run.
Asian banks operate via a traditional business model, which is to attract deposits and lend money to the market for revenue on interest. The scale of loans exceeds that of investments, which means these banks have a large deposit base from diversified sources including both individual and corporate clients.
From a regulatory perspective, the banking sector in Asia is highly regulated. To ensure ample liquidity, banks are required to comply with strict regulations on liquidity coverage ratio and often times the liquidity level of financial institutions in the region exceeds that of the regulatory requirements. Furthermore, the capital ratios of banks are captured in unrealised investment losses, providing a more transparent view of their financial conditions.
Asian bonds expected to deliver relatively stable returns
In conclusion, despite concerns of a recession in the US, macroeconomic fundamentals in Asia appears to be resilient. When major central banks in the region maintain stable interest rates, the expectation is that Asian bonds can provide relatively stable income. In particular, we currently favour investment grade bonds. From a thematic view, high-yield bonds from the Macau gaming industry offer relatively higher returns, which are worth paying attention to. We also take a positive view on India's new energy and infrastructure industry, which are being supported by government policies. Moreover, high-quality corporate credit from Hong Kong and South Korea could also provide decent investment opportunities.
Given the risk of an US economic recession in the second half of 2023, investing in bonds across various Asian markets could enable a diversification of risks, as well as help attract capital into the Asian bond markets. Even so, careful selection of a bond investment strategy is crucial.
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