The first quarter of 2019 revealed a marked change in the tone of developed central banks, with the US Federal Reserve (Fed) and the European Central Bank (ECB) adopting a more accommodative stance. This boosted 2019’s bond market rally, suppressed yields even further and increased the value of the global fixed income market.
However, a wave of elections, especially across Asia, could potentially trigger some volatility.
CENTRAL BANKERS MAKE A POLICY U-TURN
Central banks in the US and Europe have proved surprising with a more downbeat than expected outlook.
The Fed solidified its dovish policy U-turn by holding rates steady at the target range of 2.25-2.5%, scaling back its balance-sheet reduction programme, and signalling a drop in plans to hike rates again in 2019.
The Federal Open Market Committee’s (FOMC) dot plots signal only one increase could be on the cards in 2020. This is a significant downward revision from December 2018’s FOMC meeting, where its minutes suggested two rises for 2019, and a third in 2020.
The ECB added to the looser policy theme in March, when it announced its intention to push back rate-hike plans until at least the end of 2019. It also announced fresh funding for banks via a series of targeted longer-term refinancing operations.
NOT BETTING ON A RECESSION - YET
The second quarter of 2019 is likely to be a watershed moment for financial markets.
Investor and market panic in the last quarter of 2018 was swiftly followed by a rapid and broad capitulation by central banks. The question now is whether this reflects the elevated risk of a coordinated global slowdown (or even recession) that markets worried about, or the restart of a new reflation wave?
The behaviour of US fixed income markets provides some clues as to which way investors are leaning on this question. They began the year with near neutral returns in US Treasuries but have rapidly chased returns in the first quarter of 2019. By the end of March, aggregate demand for US Treasuries hit a 12-month high.
The brief inversion of the three-month, 10-year yield spread has contributed towards fears of a recession given the signal’s track record in the post-war era. However, while aggregate demand for US Treasuries were as strong as they were a year ago, demand across the curve is very different today.
Demand for Treasuries at the front end of the curve, which rose to a five-year high last quarter, led this year’s surge.
This trend stands in contrast to 2018, when demand was entirely led by appetite for the longer-dated Treasuries. Just as there was a clear desire to lengthen portfolio duration last year, so there is a desire to shorten duration today. Also of note is that demand for the belly of the curve, which typically performs well during recessionary periods, has so far been relatively neutral. Investors are enthusiastically buying Treasuries, although they are not betting on a recession just yet, and at these yield levels, are reluctant to add to their overweight at the long end of the curve.
RETURN TO LOCAL CURRENCY EM DEBT MARKETS
Long-term investors have underweighted emerging market debt, but some threats are clearly diminishing.
The Fed’s capitulation means the risks of rising US rates and a strengthening dollar are modest. On balance, news about the US-China trade dispute appears to be meandering to a more constructive outcome. And the recovery in EM currencies means that the inflation threat has also turned.
In response, even though recession risk has risen in developed markets, long-term investors continue to return to local currency debt markets. This trend is especially true in Mexico, Indonesia and South Africa.
ELECTIONS MAY TRIGGER VOLATILITY
On the political front, emerging markets have been gearing up for high-profile elections this year, which could potentially add some uncertainties to economies. Indeed, Asia will be at the epicentre of the story in the coming months:
- Thailand held its first general election since a military coup in 2014, although results aren’t expected until May. If the current prime minister, pro-military leader Prayut Chan-o-cha retains his post, the move could potentially be positive for continuity in economic policies.
- India’s general election is scheduled to take place over seven stages between April and May. Polls currently point to the re-election of the Narendra Modi government, which would underpin the country’s reform path and focus on accelerating growth measures.
- Indonesia’s presidential ballot took place on 17 April 2019. Although Indonesian President Joko Widodo and his ruling coalition have declared victory, the nation’s electoral commission is expected to officially announce winners on 22 May 2019.
- The Philippines will also hold mid-term elections on 13 May 2019. Approval ratings for President Rodrigo Duterte have been strong in recent months, also suggesting some element of certainty.
Emerging market debt rallied in March, with both hard and local currency issues generating positive returns. Asian hard currency and local currency bonds, in particular, recorded total return of 4.9% and 3.2% respectively in the first quarter of 20191.
Investors are seeking risk opportunities with a notable focus on high-yield and investment-grade-quality credit. With yields at multiples of their developed peers, Asian bonds continue to offer attractive investment opportunities.
Visit www.abf-paif.com* for our latest insights and investment ideas for Asian fixed income.
1 Source: Bloomberg, data as of 31 March 2019. Asian hard currency bond return was based on the return of JP Morgan Asian Credit Index. Asian local currency bond return was based on the return of Markit iBoxx ABF Pan-Asia Index.
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