The Asian credit market is looking less attractive to investors, but value can be gained with some finesse
Jim Veneau says despite instability in the euro zone, the strengthening US economy and an over-supply of Asian bonds have made the Asian fixed income space challenging
Asian credit markets have begun to stabilise after a sharp sell-off, which began in mid-April and intensified during the first half of May. After a flat return in March, the JP Morgan Asian Credit Index (JACI) posted a -0.66 per cent return in April. It then fell a further 0.71 per cent through May 9 before rebounding. Through May 25, JACI’s return was modestly negative at -0.12 per cent.
The sudden and severe sell-off in April and early May has brought a return to relative value opportunities in Asian credit. What remains challenging is positioning for relative value without substantially changing overall portfolio risk levels. At a minimum, the spike in volatility argues for a continuation of cautious risk positioning at an overall portfolio level, but it also implies more opportunities for active portfolio management to generate performance with systematic and well-executed pair trades.
The US also saw a modest easing of growth in GDP data in the first quarter of 2018, registering a 2.3 per cent annualised growth rate after a 2.9 per cent outcome in the fourth quarter of 2017. However, the slowdown was less marked than in Europe and other data reports have continued to be strong, including reports on the housing market and consumer confidence.
This is likely to remain a feature of the US market for some time as the effects of looser fiscal policy have an impact on the economy. So far in 2018, the US Treasury market has delivered almost -2 per cent in total returns in dollar terms, which for European investors translates to a hedged return of -2.8 per cent.
The macro environment means that European yields will remain low for some time – at least until the ECB sends some stronger signals about ending quantitative easing and moving away from negative interest rates – and that the cost of hedging any US dollar exposure back to the euro will remain a significant negative cash-flow.
Some significant outperformance of US fixed income relative to European bonds would be necessary to offset the cost of hedging and we are not quite at the point in the cycle where this is likely. A major question for all global fixed income investors is whether the ECB will be able to begin its adjustment process towards more normal interest rates before the Federal Reserve has completed its tightening cycle.
On the local currency front, high-yielding local currency bonds have suddenly lost a bit of appeal as offshore US dollar bonds have substantially cheapened while local foreign exchange volatility has worsened.
Eventually, exchange rates will reach levels that make high-yielding local currency bonds attractive again, but focusing on relative value opportunities in the offshore credit space currently makes more sense.
Jim Veneau is head of fixed income, Asia, at AXA Investment Managers