Portfolio managers and private banking clients were behind this week’s haphazard sell-off of Asia sovereigns and corporate bonds, caught out by the US Federal Reserve’s signals to taper off quantitative easing.
Bond traders and strategists say both high-yield and high-grade bonds – ranging from emerging market issues from countries such as Indonesia and the Philippines to those from leading Asian banks and conglomerates – had suffered.
Amid perhaps the biggest sell-off since October 2011 – caused by the then-unraveling European fiscal crisis and woes in Greece – the level of risk aversion was typified by a 30 cash-point drop of longer-dated Philippine sovereign paper.
“There isn’t a lot of differentiation between credits. People are not looking at valuations now; they are just reducing risk, with prices and dislocations all over the place,” says a Hong Kong-based senior credit trader.
For the Philippines – upgraded by rating agencies such as Standard & Poor’s to investment grade earlier this year – traders say the 30 cash-point slide in sovereign-debt prices within six weeks points to a race by portfolio managers to secure liquidity in preparation for redemption requests from bond fund investors.
“Liquidity in the market dried up so quickly that over the past few weeks, portfolio managers have seen selling benchmark sovereign paper that they would not even have sold during the global financial crisis,” says a head of credit research at a global bond dealer in Hong Kong.
Secondary market liquidity in global bonds had already been deteriorating in recent years. Various regulations in the post-financial crisis era such as the US’s Volcker rule and more stringent bank regulatory capital requirements such as Basel III are making it more expensive for dealers to hold inventory.
The risk-off market sentiment is also evident in wider bid-ask spreads quoted in Asia trading hours for US high-grade corporate bonds, blowing out to 30bp, from 10bp, two months ago, the senior trader says. The widening of spreads is also obvious in the HSBC Asian dollar bond index, which was quoted this week at 339bp, having risen from its tightest level this year of 250bp on January 7.
This compares to a record 437bp hit during the peak of the European sovereign crisis-related sell-off on October 4, 2011.
Dilip Shahani, head of global research for Asia Pacific at HSBC in Hong Kong, says the sell-off was caused by investors being surprised by the timing of the Fed’s recent exit signals.
Earlier this month, Fed chairman Ben Bernanke for the first time hinted at an end to the Fed’s third round of quantitative easing, saying that if unemployment figures and inflation d improve as it expects, the central bank will begin to taper off its asset-buying programme through to mid-2014.
Investors fear that interest rates may start quickly moving in the other direction, so they are exiting positions in an already illiquid market, industry players say.
“The correction has been caused by investors’ concern about interest rates, rather than the creditworthiness or health of the financial system, which is what we saw in the sell-offs that happened in September and October 2011 on the back of the European fiscal crisis,” Shahani says.
Another contributor to the sell-off has been portfolio managers managing bond funds that are benchmarked to developed-market indices with limited weights to emerging markets, says Krishna Hegde, head of Asia credit research at Barclays Capital in Hong Kong.
Aside from investing in developed market securities, these managers seek exposure to emerging market bonds to boost yields.
But due to the sudden change of views on US assets, combined with a poor outlook for emerging markets, these managers became less inclined to maintain their EM positions and began reducing their investments in EM bonds.
“These managers are likely to continue reducing their positions over time, as the illiquidity of the market has meant they cannot sell down their positions quickly in a short time-frame,” says Hegde.