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Tighter monetary policy conditions in the US, trade conflicts, and political upheaval made 2018 a turbulent year for Asian and emerging markets with stocks, currencies, and bonds all coming under pressure. In November, however, sentiment improved with Asian assets posting a late-year recovery, raising the question of whether this trend would continue into 2019. The answer depends largely on the opposing influences of longer-term positive factors – such as favourable interest rates, the region’s consistently strong fundamentals, and recent economic initiatives – and shorter-term headwinds. Overall, we believe the outlook is positive for Asian local currency bonds in the long run.
Trade tensions slacken growth
Escalating trade tensions between the US and China took a particularly acute toll on Asia in 2018 with the combined GDP growth of the five largest Southeast Asian countries — Indonesia, Malaysia, the Philippines, Singapore, and Thailand — slowing to 4.5% in Q3 2018 from 5.5% the previous quarter. Despite a 90-day halt on the imposition of new tariffs agreed in December, the trade dispute will remain one of the region’s biggest concerns for at least the next few months. Meanwhile, China’s economic expansion also slowed because of trade tensions but is still forecast to reach its target of 6.5% for 2018 before easing to around 6% in 2019.
In response to the slowdown and the weakening trend across Asian currencies, central banks took decisive action. Policies have varied from country to country, however, ranging from China cutting the reserve requirement ratio four times in 2018 to Indonesia raising interest rates six times and curbing imports. Central bankers will continue to play an influential role in 2019.
Decisive action strengthens fundamentals
Proactive central bank activity in the region was critical to the recent recovery. Currencies and Asian local currency debt reversed their declines, and the current valuation of the asset class presents a potentially attractive entry point for investors.
In the wake of monetary measures taken in Indonesia and the Philippines, for instance, the countries’ currencies are starting to advance. Bank Indonesia is maintaining its hawkish stance, suggesting the potential for further rate hikes in the coming few months, especially if the Indonesian rupiah continues to weaken. Similarly, a declining currency and rising inflation in the Philippines led to monetary tightening, a policy that is expected to be maintained in 2019 if there is no sign of inflation easing. The central banks of both Thailand and South Korea raised interest rates in 2018 and there is potential for further hikes in the coming months if growth and inflation stay on track. Moreover, while China’s authorities have shown willingness to do whatever necessary to prevent significant depreciation of the yuan, we expect the currency to remain within its recent trading range of 6.86-6.90 against the US dollar.
In addition to the impact of Asian central bank decisions, expectations of a rate hike by the US Fed have lowered recently. With US interest rates just under the neutral level, a slowing global economy, and a possible peak in US inflation, we may see a less hawkish Fed in 2019. This would further support the recovery of Asian assets in the coming year.
Hawkish policies generate higher yields
The aggressive tightening by central banks both regionally and in the US played a key role in driving Asian bond yields higher in 2018, with the exception of China. With several of Asia’s central banks likely to remain hawkish in 2019, we expect yields to continue to rise. In Indonesia and the Philippines, yields could also be driven higher by concerns over their widening current account deficit. Indonesia’s 10-year yield, for instance, has increased to an enticing 7-8%. The higher yields on offer in Asia relative to developed markets will remain a significant draw for investors.
Positive outlook with a risk of headwinds
A stronger US dollar and concerns over emerging markets resulted in a repricing of the Asian local currency bond market in 2018. Looking ahead, we should beware of potential headwinds, in particular from the US-China trade war and its fallout in the region. There are also specific regional risks such as concerns about whether Malaysia’s new Government can address the country’s debt burden, and whether China’s ongoing deleveraging will expose corporate weakness.
Overall, however, Asia goes into 2019 with improving fundamentals, attractive valuations, and higher yields. The inclusion of Chinese bonds in global indices and other positive developments in the region are likely to further improve sentiment towards Asian local currency debt.
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