Why Asian local currency bonds look appealing in a world of the Zero
Why Asian local currency bonds look appealing in a world of the Zero
As we have highlighted with The Zero, generating income returns has rarely, if ever, been harder. What has been a key feature of markets since quantitative easing was introduced after the 2008 global financial crisis, has been compounded by further ultra-accommodative measures in response to Covid-19.
About one quarter of the global bond market has a yield below zero and many are close to zero, including corporate bonds. One part of the market that still offers attractive yield is the Asian local currency bond market. Here we look at some of its attributes.
Asia’s strong economic fundamentals
Emerging Asian economies have grown significantly faster than the rest of the world over the past 20 years and now contribute more than half of global GDP. Asia ex-Japan is also doing markedly better than the rest of the world, having dealt with the pandemic well. Asia ex-Japan is the only region to have grown in 2020, driven by China and Taiwan, the latter due to its semiconductor industry. The region is set to remain the strongest area of growth in the coming two years.
Asian countries’ government debt to GDP levels are low and stable, with many countries at near zero for external debt. Asian economies are less vulnerable to the volatility of global capital flows and benefit from large domestic savings pools.
Asian bond valuations remain attractive
Despite stronger fundamentals, Asian bonds are trading near the historic average or cheaper side of valuation levels versus global developed market bonds. Asia’s aggregate 3.3% yield compares to 0.8% for the US Treasury index and not much above zero for global government yields.
Compared to other emerging market sovereigns, Asian bonds are trading at the cheapest level historically. Asian bonds are only 2.0% tighter versus Latin American bonds while historically the spread has been 3.7%. This is compelling as Asia has a materially higher credit rating of A compared to BBB for Latin American sovereigns, based in S&P and Moody’s. Asia has a more stable return profile as well.
China is a key component of the Asian local currency sovereign bond market and a key factor in the attractive valuation. As China’s economy has rebounded, the People’s Bank of China (PBoC) has begun to normalise policy. The PBoC’s response to the crisis was also relatively measured and targeted, while the rest of the world unleashed further large-scale quantitative easing and other measures.
Chinese sovereign yields rose in 2020, as the economy rebounded. With little inflationary pressure and areas of the economy still needing policy support, we do not expect the PBoC to shift to a hawkish stance any time soon.
It is not all about China though. In Korea and Singapore, rates are likely to stay low as monetary policies remain accommodative, while economic activities are starting to resume. In Indonesia, a new law will make business licences easier to obtain, and could lead to a more favourable growth outlook, while inflation rate remains low. In Malaysia, attractive real rates are providing support to valuation, and rates in Thailand are likely to stay anchored until global tourism recovers. In India, rates should find support from easing inflationary pressure.
Asian local currency bonds offer diverse set of opportunities
In addition to attractive yields, Asia comprises a diverse set of opportunities. We broadly categorise Asian countries into advanced, middle income, and emerging economies. As we can see in the table the correlations to global stock and bond markets vary across these categories.
Bond markets in advanced Asian economies – Singapore, South Korea, Hong Kong and Taiwan – tend to have lower yields and behave most like developed market treasuries with negative correlations to equities.
The middle-income countries, led by China, and including Malaysia and Thailand, tend to have lower correlations to other asset classes. They are driven by country-specific factors, the growth of the domestic middle class in particular. China is now focused on “internal circulation” as its growth model, which we expect will result in continued lower correlations.
The emerging economy bonds are high yielders and more sensitive to global growth, less correlated to developed market bonds and more to risk assets. They typically deliver stronger returns during economic recovery periods. India’s limits on foreign ownership have led to low correlations.
Altogether, this amounts to a rich set of potential investment opportunities and diversification benefits. It affords scope to capitalise on specific risks, separating investment decisions on interest rates and currencies. For instance, taking the view that Thai rates may stay low, due to accommodative monetary policy, supporting bonds, but the currency may weaken due to the decline in tourism. Quasi-sovereign, or government-backed entities, and corporate bonds provide further scope for diversification.
Asian currencies have the potential for appreciation
Currency is another area of opportunity, particularly so now. There is a good possibility the US dollar is in a long-term downward trend, thanks to its ballooning twin deficits, record fiscal stimulus, zero interest rates and open-ended quantitative easing.
Historically, rising US twin deficits, in its current account and budget balance, have coincided with weakness in the dollar. Since reaching a cycle high last March during the flight-to-quality, the US dollar has declined by more than 10%. Emerging Asian currencies have benefited.
We believe the continued accommodative monetary policy as well as additional substantial fiscal support under the Biden administration could further pressure the US dollar.
If we compare budget and current account balances, we see Asian economies are in a strong position relative to the US and other countries. Asian governments are relatively fiscally restrained in spending. More effective containment of Covid-19 has enabled them to be, while they are less impacted by commodity price fluctuations. Asian economies also benefit from the improvement in manufacturing activities as well as increased trade.
Source of income and diversification
We see positive prospects for Asian bonds, with continued positive returns, attractive yield levels and moderate volatility relative to other emerging markets and some global bond sectors. Asian local currency bonds are supported by broadly positive fundamentals, moderate growth and inflation and stable finances, as well as a range of country and market-level characteristics.
The share and importance of Asian economies and capital markets are widely expected to continue to rise in the coming years. Asian local currency bonds look like an area of the fixed income market that still has the potential to deliver attractive income returns in today’s low yield world.
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