Credit: Bloomberg
As inflation expectations rise and bond yields spike, Asian bonds have remained relatively resilient. We examine three factors that are helping to support the region’s fixed income markets.
The biggest story in the bond markets right now is a return of the “taper tantrum” we saw in years gone by. Although the Federal Reserve has not indicated any monetary tightening, bond yields in many developed markets have spiked on greater inflation expectations resulting from the new US$1.9 trillion ($2.5 trillion) US stimulus package. The 10- year US Treasury yield hit 1.67% on March 26, 2021 — its strongest level in over a year and almost 75 basis points (bps) higher than end-2020 levels. Ten-year UK gilts surged from 0.20% to 0.76% over the same period, while 10-year German bonds moved from –0.58% to –0.35%.
This development has impacted Asian equities, with many stock markets in the region seeing outflows and declines in February 2021. Yet, against this backdrop, Asian bonds have remained resilient. Yields on the Markit iBoxx ABF Pan-Asia Index — which tracks the performance of local currency government and quasigovernment bonds in eight Asian markets — increased by 22bps to 2.88% from Jan 31 to Feb 28, 2021.
Foreign investors remain as interested as ever, as they exit developedmarket bonds to find refuge in Asia. They have already bought a net US$41.5 billion of Chinese bonds since the beginning of 2021 — a third of 2020’s total purchases. This trend has been even more robust in other emerging Asian bond markets, which have seen total inflows of over US$2.8 billion, over 60% of last year’s total.
What lies behind such a resilient performance?
Relative yields continue to drive investor interest
At the heart of Asian bonds’ enduring appeal are their attractive relative yields. As an example, consider that as of March 9, 2021, government bonds from China, Indonesia, and Malaysia offered yield pick-ups of 170–520bps over US Treasuries. That is a substantial carry — but, arguably, without a considerable increase in risk.
With increasing growth optimism in developed markets stemming from significant vaccination progress and economic reopening, yields are likely to keep moving upwards. This could further spur more investors — already spooked by the recent tantrum — into Asian fixed-income markets.
Diversification benefits persist
Beyond the yield story are the ongoing diversification benefits that Asian bonds — particularly of the localcurrency variety — offer to investors. The region’s bonds have continued to maintain their low correlations with their developed-market counterparts and equity markets. This is an alluring advantage in a world where correlations are increasingly converging.
There are a few likely reasons for this. One is the relatively low onshore holdings from foreign investors. Looking at the data for localcurrency government bonds, while some markets like Malaysia and Indonesia have comparatively higher foreign ownership rates of about 25% as at end-2020 (with historical peaks closer to 40%), others are far lower. For instance, China’s foreign holdings have generally remained under 10%, Thailand and Korea are sub-15%, and markets like the Philippines come in below 5%.
Another reason is the “buy and hold” mentality entrenched among domestic institutional investors — the primary owners of local-currency government bonds. And finally, there is the long-term macro view to consider.
Asia’s economic growth story
While rising bond yields negatively impacted both equity and fixed income investors alike (especially in developed markets), they are generally a sign of growth optimism, in this case stemming from the new US stimulus programme and vaccination progress. But much of this growth is likely to be realised in Asia, which will benefit from the spillover from the US’ liberal fiscal policy.
The fundamentals for a revival in Asian economies — much less dependent on fiscal and monetary stimulus — are all there. In terms of global trade, the United Nations Conference on Trade and Development reports that much of the rebound in international trade in the last quarter of 2020 stemmed from Asia. Without these economies, global trade flows would have continued to decline.
Another fundamental aspect to look at are the current account balances. For example, China has overtaken Germany to have the world’s largest current account surplus. South Korea’s current account balances have recovered, Singapore and Malaysia posted their highest surpluses in nearly a decade, and Indonesia revealed a second straight quarter of surpluses after being in a deficit since 2011.
This is not to say that there aren’t any risks. Because Asian economies have better managed the pandemic, there has been less urgency in their vaccination programmes as compared to the West. This creates the risk that they could be “left behind” as other economies reopen. However, this is a shorter-term risk.
From a longer-term macro perspective, Asian markets remain well-positioned fundamentally.
A continued resilient play
The recent spike in bond yields was a major market event. And it did affect Asian bonds, even in the local currency space. The relatively muted impact demonstrates resilience and bodes well for the future.
Kheng-Siang Ng, CFA, CAIA, is Asia Pacific Head of Fixed Income at State Street Global Advisors
