People walk over a pedestrian bridge in Shanghai on July 8. China’s success in managing the Covid-19 pandemic has limited the long-term damage to its economy, making it an attractive investment destination. Photo: EPA-EFE
Adam McCabe and Robert M. Gilhooly
Adam McCabe and Robert M. Gilhooly

Coronavirus recovery and US dollar weakness put Asia in bond investment spotlight

  • Asian economies are more advanced in their pandemic recovery than their Western peers, having demonstrated greater state capacity to manage the crisis
  • Expected US dollar weakness will support Asian and emerging-market currencies while boosting prospects for hard currency Asian bonds

Asian financial markets could reap the benefits if US President-elect Joe Biden proves more conventional than his predecessor in the White House, potentially triggering a reallocation of global capital to the region.

Consensus expectations point to less confrontational diplomacy for a Biden administration, creating less geopolitical headline risk, fewer market shocks and reduced volatility. Any warming of US-China ties would relieve pressure on global supply chains, which would be positive for foreign direct investment into Asia.

A reduction in volatility would also be positive for Asian markets in general. It could encourage investors to refocus on the fundamental strengths of governments and companies in the region.

Asian economies are more advanced in their pandemic recovery than their Western peers, having demonstrated greater state capacity to manage the crisis. China, Singapore, South Korea, Australia and New Zealand appear likely to suffer less long-term structural damage to their economies.

In addition, Biden might roll back some US corporate tax cuts and deregulations implemented by sitting President Donald Trump. That could strengthen the appeal of non-US companies, including those in Asia.

The likelihood of a smaller fiscal support package suggests US monetary policy will remain accommodative while the economic impact of the coronavirus pandemic will be disinflationary. This could point to US dollar weakness while supporting Asian and emerging-market currencies.

Against this backdrop, the prospects for hard currency Asian bonds look positive, offering superior risk-adjusted returns. Asian issuers boast lower net gearing than US issuers as their economies have suffered less long-term damage from the pandemic and recovered more quickly.

Reflective of this, there were more credit ratings upgrades than downgrades for Asian investment-grade issuers in the last quarter. The default rate for Asian high-yield bonds in the past 12 months is 3.8 per cent versus 7.2 per cent for US high-yield paper. Valuations remain more attractive, too.

Further, Asian dollar credit outperformed US credit in terms of price volatility during the crisis. Average peak-to-trough drawdowns were lower for Asian dollar credit than for US credit during the height of the crisis in March.

Among local currency fixed income, Chinese bonds stand out. China remains the only A+ rated sovereign debt market yielding above 3 per cent over 10 years. That provides a greater yield cushion in the event of a further risk-off environment.

By contrast, 10-year developed market government bond yields were between 0 and 0.9 per cent, with German Bunds in negative territory. From a traditional asset-allocation perspective, this leaves investors nowhere to turn for defensive assets.

Furthermore, the inclusion in the Bloomberg Barclays and JP Morgan’s international indices and pending inclusion in the FTSE World Government Bond Index in October 2021 are near-term catalysts to support China’s onshore bond market.
This is driving record monthly inflows into Chinese onshore bonds. The strength of China’s economic recovery, combined with prospects of a weaker US dollar, suggests the renminbi will remain well-supported.

Beyond government and policy bank bonds, foreign investors own just 2 per cent of China’s onshore bond market versus 20 per cent for Japan, a market of comparative size. It underscores how global investors might need to look at China’s market differently.

From a corporate perspective, we are positive about China’s high-yield property sector as there has been a strong recovery in sales and some high-yield sectors in the Middle East.

There has been a lot of headline noise about regulators looking to deleverage China’s property market. This led to a sell-off among developers, and they have yet to recover fully.

This tightening of financial conditions was designed to guide developers on what they can borrow in future to better manage their balance sheets, not squeeze them of liquidity. As a consequence, there are value opportunities in this sector.

Adam McCabe is head of fixed income – Asia and Australia. Robert M. Gilhooly is senior emerging markets economist at Aberdeen Standard Investments

This article appeared in the South China Morning Post print edition as: Prospects for Asian bonds look positive