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Emerging market debt (EMD) has suffered during the recent global turmoil for multiple reasons. First, it has been considered a risk asset and so has seen investors exiting it for safer investments, even though many key central banks have cut rates and started their own asset purchases. Second, the grab for yield and relatively strong performance of emerging market funds meant investors were fairly ‘long’ EM investments ahead of the turmoil. Third, for local currency debt there has been the double impact of the aggressive bounce in the USD. Last, a number of emerging markets have ecovnomies that are heavily exposed to commodities and suffered, in particular, when oil prices fell sharply.
Year to date, China bonds showed relative strong performance versus its emerging market peers, with the country recording both FX and price gains. Rate cuts from the central bank and an aggressive early lock-down to deal with COVID-19 have delivered some support for bonds but that cannot explain fully the outperformance. This stability appears to be more about the CNY’s growing importance as a reserve currency and the fact that Chinese bonds have been adopted domestically as an alternative safe haven to US Treasuries just as foreign investors are increasing investments into Chinese renminbi bonds.
The broader Asian bond markets find themselves pulled in opposing directions. On the one hand, yields are being depressed by continued monetary easing as central banks around the world continue to slash interest rates to revive stalling economies. On the other, yields are being pushed up by a global flight to safety as some foreign investors exit certain Asian bond markets. Foreign outflows from Asian bonds totalled US$17.28 billion in March – the highest since January 2013.1
Such mixed driving factors of Asian bond performance can give the impression of greater and ongoing volatility for the asset class. But Asian bonds are not a monolithic entity, and these contradicting forces affect each sub-category differently. This diversity is the source of the potential for pockets of opportunity.
Asian bond market divergence
After weeks of battling it out, OPEC+ nations – except for Mexico – reached a historic agreement on 10 April 2020 that would see crude production cut by 10 million barrels per day beginning May. However, this did little to support oil prices, which slid further, at one point falling below the US$20 per barrel mark. The size of the crude oil glut was also starkly revealed when an expiring May contract for West Texas Intermediate crude fell into the negative territory on April 20, driven by fears that there would be nowhere to store the delivered oil.
The prospect of continued depressed oil prices, however, is a near-term boon for most Asian countries, including China, the world’s largest net oil importer, Korea and Taiwan. Exceptions are a few net exporters such as Malaysia, Vietnam, and Brunei.
The fall in energy prices also offsets the impact on inflation resulting from the significant weakening of a number of emerging market currencies in the past months. The combination thus far means that headline inflation is still headed lower. This will be helpful for central banks, providing them with more room to ease monetary policy, which may place further downward pressure on bond yields.
The impact of a strong US dollar on Asian bonds amid a global flight to safety affects each country differently. Countries such as Indonesia and India, which are facing twin deficits in their budget and current accounts, are more reliant on foreign inflows and thus more exposed.
Central banks to the rescue
COVID-19 presents a set of challenges that are different from the previous crises but, crucially, central banks have acted quickly. Rate cuts and bond support programmes were initially deployed to limit the worst effects of the economic slowdown on households and businesses.
A key objective for central banks is to keep credit flowing to corporates. In China, which remains the brightest star in the Asian bond constellation, first-quarter corporate bond defaults fell 30% year-on-year as the government pressured banks into keeping enterprises afloat with easy financing.2
On the other side of the globe, bond buying programmes for corporate bonds have been reactivated by the US Federal Reserve (the Fed), European Central Bank and Bank of England. The Fed has announced it will purchase corporate bond ETFs, and has made an unheard-of foray into buying bonds that had recently lost their investment-grade status – so-called ‘fallen angels’.
Potential attractive entry opportunities
Despite contradicting forces on Asian bonds and divergence within the asset class itself, we believe, on balance, that overall yields will trend lower – which may create attractive entry opportunities for those practising careful asset selection.
Due to the degree of the sell-off, there is scope for a rebound. Positive returns in Asian bonds can come through various sources: gradual economic recovery; rebound in local currency bonds against the USD; and central banks starting to buy domestic bonds.
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1 Source: The Edge Markets, 13 April 2020.
2 Source: Nikkei Asian Review, 7 April 2020.
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