Kheng-Siang Ng

The answer to this is likely to be found between longer-term positive factors such as favourable interest rates, the region’s consistently strong fundamentals and recent economic initiatives, and near-term headwinds. Overall, we think the outlook remains positive for Asian local currency bonds in the long run. 

TRADE DISPUTE SOFTENS GROWTH

Escalating trade tensions between the US and China took a particular toll on Asia in 2018, with, for example, the combined GDP growth of the five large Southeast Asian countries (Indonesia, Malaysia, the Philippines, Singapore and Thailand) slowing to 4.5% in Q3 2018, from 5.5% in the previous quarter. Despite the temporary 90-day halt on the imposition of new tariffs, which was agreed in December, the trade dispute will remain one of the biggest concerns in the region over the next few months. Meanwhile, China’s economic expansion has also been impacted; however, it is still forecast to reach its target of 6.5% in 2018, before easing to around 6% in 2019.

In response to the slowdown and the weakening trend across Asian currencies, central banks took decisive actions. That said, policies have diverged across countries, from China’s authorities cutting the reserve requirement ratio four times during 2018, to Indonesia raising interest rates six times and placing curbs on imports. Given these circumstances, 2019 is likely to keep Asia’s central bankers on their toes.

POLICY STRENGTHENS FUNDAMENTALS AND STABILISES CURRENCIES

Proactive central bank activities in the region are one of the critical factors leading to the recent recovery. Asian local currency debt and currencies reversed their decline, and the current valuation of the asset class may present an attractive entry point for investors.

For example, in the wake of measures taken in the Philippines and Indonesia, the countries’ respective currencies are starting to advance.

Bank Indonesia is maintaining its hawkish stance, suggesting the potential for further rate hikes in the next few months, especially if the Indonesian rupiah continues to weaken. Similarly, a declining currency and rising inflation in the Philippines may make monetary tightening a policy that should remain in place in 2019, if there are no signs of easing inflation.

Both the central banks of Thailand and Korea raised rates in 2018, with the potential for further hikes in the next few months if growth and inflation go in their expected directions. Moreover, while China’s authorities have shown willingness to do whatever it takes to prevent a significant depreciation of the yuan, we expect the currency to remain within its recent trading range of Rmb 6.86-6.90 against the US dollar.     

In addition to these ongoing actions of Asian central banks, expectations have recently been lowered for the US Fed’s rate hike plans. With US interest rates just under the neutral level, combined with a slowing global economy, and a possible inflation peak in the US, we may see a less hawkish Fed policy in 2019. This would further support the recovery of Asian assets in the coming year.

HAWKISH CENTRAL BANKS LEAD TO HIGHER YIELDS

The aggressive tightening action of central banks, both regional and in the US, played a key role in driving Asian bond yields higher in 2018 (except for China). And with several of Asia’s central banks likely to remain hawkish, we expect yields to continue rising.

In Indonesia and the Philippines, yields could also be driven higher by concerns over their own widening current account deficits. Indonesia’s 10-year yield has increased to a compelling range of 7-8%. The higher yields on offer in Asia, relative to developed markets, will remain one of the key attractions for investors.   

A POSITIVE OUTLOOK BUT HEADWINDS REMAIN

2018 was very much a story of a stronger US dollar and emerging market concerns, resulting in a repricing of the Asian local currency bond market. Looking ahead, we need to be aware of potential headwinds, in particular, the uncertainty around the US-China trade war and its impacts on Asia in general.

On a regional level, there are also idiosyncratic risks, such as concerns as to whether Malaysia’s new government will be able to successfully address the country’s debt burden, while China’s ongoing deleveraging may expose corporate weakness.     

Overall, Asia is set to start the new year with the appealing factors of improving fundamentals, attractive valuations and higher yields. Other notable developments in the year ahead, such as the inclusion of Chinese bonds into global indices, are likely to bolster sentiment towards Asian local currency debt.

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