With interest rates low and falling across many global markets, high-yielding Asian markets are standing out. Bonds worth over USD15 trillion — about a quarter of the debt issued by governments and companies globally — now yield less than zero.1 Yet 10-year government bonds in countries such as India2 and Indonesia3 still yield as much as 6-7 per cent.
Following the US Federal Open Market Committee (FOMC)’s lead, central banks are responding to weaker growth – spelling the likelihood of an impending monetary-easing cycle. In a sudden reversal from its stance at the end of 2018, the FOMC has moved from tightening rates to easing them, as it focuses on reducing inflation and stalling faltering growth. Other central banks are signalling a similar approach, as economic activity drops globally.
The US-China trade tensions have exacerbated the situation, but they are not the root cause. The seeds of lower global growth were already sown by the time tensions escalated in the first half of 2018.
The prospect of lower interest rates is evidently positive for fixed-income markets globally. However, this will be most beneficial for Asia – local policy rates were too high to begin with, leaving room to cut them aggressively. Furthermore, the FOMC’s interest rate cuts are likely to end a seven-year period of US dollar strength, further alleviating inflationary pressure in Asia and creating even more room for rate cuts.
Brighter bond markets
The current situation could not be more different to 2018. It was a difficult year for Asian fixed income, but one that laid the foundations for today’s benign environment.
In 2018, the FOMC tightened monetary policy and US long-term rates rose. This trend underpinned the strong US dollar, which ratcheted up inflationary pressures in Asia. Higher oil prices then added to the pressure and as a result, several countries were left with little option but to raise policy rates to avoid importing inflation. Interest rates ended the year higher than they needed to be.
Fast forward to 2019 and GDP growth is slowing across Asia. While the slowdown is most pronounced in North Asia, growth across South-east Asia is also decelerating. As growth slows, South-east Asia’s central banks have more room to cut policy rates than others, to the benefit of bond markets.
Despite the general slowdown, some markets in South Asia and South-east Asia still have relatively high growth and interest rates. For example, the Bank’s projection for India’s GDP growth is about 7 per cent in 2019, Indonesia’s at 5 per cent, Malaysia’s between 4.5 to 5 per cent and around 6 to 6.5 per cent GDP growth for the Philippines’. This stands in sharp contrast to North Asia, where South Korea and Taiwan have far lower growth rates of about 2 per cent, due in part to the downturn in the technology sector.
With far more room to cut rates, it stands to reason that the likes of India and Indonesia will have better-performing bond markets than the likes of South Korea and Taiwan.
Compounding 7 per cent growth rates
The markets now in this favourable position were in fact those that were hardest hit in the Asian financial crisis of 1997, partly caused by high current account deficits. Since then, countries such as Indonesia have substantially reformed their economies to become far more resilient today. This suggests that Asian currencies will continue to become more stable, and that the gap in yields compared with developed economies should narrow somewhat.
Looking forward, the prospects for many Asian countries’ fixed-income markets look broadly positive for years to come. Even with the current slowdown in growth, many of these markets are booming; India’s is growing at 7 per cent a year, and Indonesia’s growth rate might also increase towards 7 per cent if President Joko Widodo uses his recent election victory to implement reforms. At growth rates of 7 per cent, economies double in size every 10 years. As economies grow, so fixed-income markets tend to expand and open up, creating more opportunities for investors.
China is a perfect example of this. While growth slowed to 6.2 per cent in the second quarter of 2019, China enjoyed 30 years of high growth rates, which transformed the size of its economy. Its near-USD13 trillion onshore bond market is now the world’s third biggest, and is increasingly diverse – with a broadening of the credit market that allows investors to be more tactical.
Expecting a virtuous circle
Returning to the second half of 2019, the Bank’s prediction is that FOMC interest rate cuts will trigger a fall in the US dollar against Asian currencies, diluting inflationary pressures in Asia further still. This should be the catalyst for the region’s most attractive bond markets to outperform.
Uncertain times for the global economy present a silver lining for South and South-east Asia. Expect a virtuous circle of stronger currencies, lower inflation, falling rates and rallying bond prices.
1 Negative rates: investors go through looking-glass to sub-zero yields. FT. August 13, 2019, para 2. https://www.ft.com/content/820e3aac-ba1a-11e9-8a88-aa6628ac896c
2 Trading Economics, as of August 13, 2019, summary para 1. https://tradingeconomics.com/india/government-bond-yield
3 Trading Economics, as of August 13, 2019, summary para 1. https://tradingeconomics.com/indonesia/government-bond-yield
4 Financial Times, China’s economy grows at slowest rate in 30 years, July 15, 2019, paragraph 3 https://www.ft.com/content/73f06b8a-a696-11e9-984c-fac8325aaa04
5 Global investors may spur change in China’s USD13 trillion debt market. Bloomberg. March 29, 2019, para 2. https://www.bloomberg.com/news/articles/2019-03-28/global-debut-for-china-s-13-trillion-debt-gives-pboc-new-ally
This article was also published by Euromoney.