Asian fixed income: seizing the opportunity

Asian fixed income experienced an eventful year in 2021. Two macro factors played an important role in the asset class’s performance:

• Regional economies gradually recovered from the COVID-19 pandemic, which had sent nearly all of them into recession. The recovery, however, was uneven, with North Asia generally recovering faster due to better virus containment measures and relatively higher immunization rates. On the other hand, India and Southeast Asia experienced recurring waves of infection due to less developed healthcare infrastructures and lower vaccination rates. 
• The U.S. Federal Reserve (Fed) and other major global central banks maintained their accommodative monetary policies introduced when the pandemic began in 2020. This provided ample liquidity for financial markets throughout the year. However, as inflation fears mounted with rising consumer prices, the Fed announced an accelerated tapering of bond purchases after its December meeting, with most members of the FOMC forecasting at least three rate hikes in 2022.   

Against this macro backdrop, Asian credits’ performance sharply diverged in 2021. The J.P. Morgan Asian Credit Index (JACI) declined by roughly 2.3%. This figure, however, masked the notable divergence between investment-grade (IG) and high-yield (HY) credits: The JACI IG Index has been broadly flat (year to date), but the JACI HY Index declined by roughly 11% over the same period.¹

There are several reasons for the divergence. Since July 2021, the Chinese government announced a raft of measures that changed the regulatory landscape in economically and socially important sectors such as the internet and educational services (after-school tutoring). 

Even more crucially, previously introduced regulations pertaining to the real estate sector, such as The Three Red Lines policy, introduced in August 2020, had limited debt-related funding for overleveraged firms such as Evergrande, the second-largest developer in China at the time. In September 2021, the firm failed to make a series of payments on its onshore bonds and investment products,² which quickly spread to the rest of the sector and roiled investor confidence. This catalyzed a sell-off in offshore Chinese property bonds and resulted in a significant drag on the U.S.-dollar denominated HY market.³ Evergrande and a few other developers ultimately entered restricted default during the fourth quarter.⁴ The price dislocations caused by these events created notable opportunities for investors in Asian fixed income. Indeed, the credit spread premium for Asian credits (over U.S. credits) in both IG and HY are roughly at decade highs. We believe that HY valuations are particularly attractive, with spreads well above historical averages, providing significant opportunities next year. 

Asian credit spread premium at near-term highs

Source: Bloomberg, ICE BofA, and J.P. Morgan indexes, as of November 30, 2021. Indexes used are the J.P. Morgan Asian Investment Grade Corporate Index, J.P. Morgan Asian Non-Investment Grade Corporate Index, ICE BofA U.S. Investment Grade Corporate Index, and ICE BofA U.S. High Yield Index. It is not possible to invest directly in an index. LHS refers to left-hand side. RHS refers to right-hand side. BPS refers to basis points.

Asian HY spreads particularly attractive

2022: seizing the opportunity

Moving into 2022, we believe that credit will most likely present the most compelling opportunities for Asian fixed-income investors; however, we’re also constructive on selective opportunities in rates and currencies.  

Overall, we expect global liquidity to remain relatively accommodative from a historical perspective for Asian credits in 2022. We believe that attractive opportunities will exist in the Asian credit space throughout 2022, especially in the HY segment; in our view, some credits are excessively priced to the downside. Indeed, price dislocations, particularly in the China real estate sector, that were experienced in 2021 don’t necessarily reflect the underlying fundamentals of higher-quality developers. 

That said, robust credit research and strict credit selection are needed to find the right names that represent value in this fast-changing market, which is characterized by consolidation, uneven recovery, and challenges in the weaker areas of the market. We’re constructive on various high-yield segments across the region that offer not only competitive yields, but also offer attractive valuations and diversification properties. 

• China: property
  
  This sector was heavily sold off in 2021 due to negative news flow, concerns about rising defaults for HY issuers, uncertainty over its future economic role, and broader contagion risks. The resulting volatility, however, also offers investors like us—who had previously underweighted the sector—opportunities, as we believe the market has priced in excessive default rates. We see it as an opportune time and environment for active investors to navigate the cycle, as market weakness is likely to highlight value opportunities in fundamentally strong issuers that can steer through this episode unscathed. Bonds issued by many quality companies are offering compelling valuations with attractive entry points. 
  
  In 2022, we’re likely to see greater consolidation in the sector amid continued challenges, as stronger firms (state-owned and larger private firms) recover and may take the opportunity to acquire projects from weaker or smaller firms. More robust firms are also likely to benefit as they hold valuable collateral (projects) and benefit from government policies. 
  
  Indeed, we are beginning to see policy easing, such as relaxed mortgage approvals, eased onshore bond issuance for Chinese property developers. The People’s Bank of China (PBoC) cut the reserve requirement ratio (RRR) for banks by 50 basis points (bps)⁴ to stabilize funding channels prudently. 
  
  As a result, we’re now overweight in the sector. However, we’re highly selective when identifying winners that can navigate this cycle given the highly fluid situation. Overall, the sector is unlikely to return to its previous significant scale after years of overinvestment; it’s also unlikely to maintain strong yearly sales growth with the wide margins seen in previous cycles. Yet, we believe that reforms (e.g., common prosperity) have made it more sustainable over the long term, particularly as real estate developers have lowered their debt levels and systemic risks are gradually reduced. 

• India: renewable energy
  
  Apart from China and the property sector, we’re constructive on other strategic opportunities emerging in the region that remained resilient, particularly in India. Although some Indian credits may offer a relatively lower yield, they’re generally more stable and less correlated to volatility in the broader asset class, meaning they can serve as asset allocation tools to manage risks and maximize value. Additionally, Moody’s upgrade of the country’s sovereign rating outlook from negative to stable in October has reduced the risk of becoming a fallen angel.
  
  We’re optimistic about the renewable energy sector, which we believe should become more important as the government recently pledged to become net zero by 2070.⁵ Companies offering renewable energy solutions should benefit from increased government support and an expanding market for their products and services. These credits also help bolster the resilience and enhance the environmental, social, and governance characteristics of investors’ portfolio.  

• Asia: bank capital
  
  Finally, we’re also positive on Asian bank capital bonds. Issuance in this area is still relatively new to the region compared with more developed markets, such as Europe and the United States, as banks previously sought other channels for funding. As capital needs have increased, high-quality, state-owned, and quasi-state-owned banks in China, India, and Thailand have issued debt that we believe offers a compelling proposition for investors. Most issuers are large banks with some type of implicit government support. Indeed, due to the importance of banks to the overall economic landscape in Asia, governments and regulators may be more likely to step in. Seasoned investors will typically move down the bank’s capital structure to find a particular segment that offers an attractive risk/reward profile and from a valuation perspective, we believe Asian bonds in this segment are more compelling than similar offerings in developed markets.   
  
  In 2022, we expect issuance in this space to increase, and investors will be looking across the region to add to their portfolios selectively. 

Regional central banks in Asia should begin or continue to normalize monetary policy next year, although the pace and degree may vary greatly due to the pace of economic recovery and inflation, with the recently discovered Omicron variant being a wildcard. 

Indeed, the Bank of Korea has already raised rates by 50bps to 1%, the Reserve Bank of India stopped bond purchases in September and may raise rates in 2022, while Bank Indonesia has pledged to continue its burden-sharing agreement into next year. 

We’re generally more constructive on short duration bonds to mitigate interest-rate risk based on our current rate views. Regionally, we’re negative on Singapore and Thai government bonds and the long end of the South Korean government bond curve, which is more highly correlated with U.S. Treasuries.

We’re also constructive on two markets for longer duration in 2022 and beyond.  

We are generally more constructive on short-duration bonds to mitigate interest-rate risk based on our current rate views.  Regionally, we are negative on Singapore and Thai government bonds and the long end of the Korean government bond curve, which is more highly correlated with US Treasuries.

We are also constructive on two markets for longer duration in 2022 and beyond:  

• China

After emerging early from the COVID-19 pandemic, the country’s growth momentum has declined on a sequential basis in 2021. This trend may persist into 2022 due to continued regulatory reforms, disruption in the real-estate sector, and residual COVID-19 risks. 

Concurrently, government bond yields have remained at attractive nominal levels in 2021 (2.86% as of November 30, 2021), as the government implemented tighter fiscal policy, with China’s fiscal impulse estimated at roughly -2.5% of GDP. Monetary policy also remained selective and prudent, as the PBoC largely refrained from significant liquidity injections and didn’t engage in quantitative easing. 

In 2022, we expect further monetary loosening after the recent RRR cut of 50bps in early December. Indeed, the transition of China’s property sector and other regulatory changes should also result in some moderate loosening of the country’s fiscal stance, while additional credit and regulatory easing could provide relief. 

This should be constructive for China’s government debt and provide attractive countercyclical diversification for bond investors in a world of rising rates in developed markets. See our 2022 China bond outlook for more insight.  

• Indonesia

The country was arguably one of the hardest-hit economies by the pandemic in the region, entering recession for the first time in 22 years. The government responded with strong fiscal stimulus and import bans and forged a burden-sharing arrangement with Bank Indonesia. The agreement mandated the central bank to fund the country’s fiscal deficit through direct purchases of government debt in auctions. This arrangement was recently extended through 2022.  

Indonesia’s robust policy response has created unique opportunities for bond investors by changing it to a more domestically driven rates market. Previously, the country suffered from a chronic current account deficit that was primarily funded by foreign investor purchases of government debt. If there was a sell-off in the local bond market or global risk-off sentiment, the Indonesian rupiah would also depreciate, creating a negative feedback cycle.  

The newly adopted policies, coupled with a surge in commodity prices, resulted in the country posting its largest quarterly current account surplus in 12 years in the third quarter (1.5% of GDP). In addition, Bank Indonesia’s purchase of government debt has significantly reduced foreign ownership from approximately 27.0% in September 2020 to roughly 21.0% in September 2021, with the central bank owning more rupiah-denominated debt for the first time ever;⁵ this has notably decreased volatility for local currency bonds and stabilized the rupiah. 

On the back of these developments, we are tactically constructive on Indonesia in 2022 and believe the market holds promise over the mid to long term. 

Foreign holdings of Asian debt 

Source: Asia Development Bank, as of September 2021.

Finally, we’re more neutral on India. On the one hand, potential inclusion in global government bond indexes could happen as early as the first quarter of 2022, which would have a positive impact on the market. On the other, stronger-than-expected growth in the second half of 2021 may lead the Reserve Bank of India to normalize interest rates faster than expected, posing a headwind for the short end of the curve.  

Therefore, we are negative at the front-end of the government bond yield curve while positive on 5- and 10-year maturities, which provides a relatively higher nominal yield and carry potential. 

Most Asian currencies, except for China’s renminbi and Taiwan’s new dollar, weakened against a resurgent U.S. dollar in 2021.⁶  While the regional currency landscape is likely to be fluid in 2022, we’re constructive on two currencies. 

• Thai baht: 

Thailand’s economy was severely affected by the COVID-19 pandemic, with prepandemic tourism making up roughly 20% of GDP and total employment. Crucially, income earned from foreign tourists contributed to Thailand’s strong external position—a perennial current account surplus. Due to border closings and mobility restrictions, the current account surplus swung to a deficit in 2021 (3.6% of GDP September), causing the baht to become the worst-performing regional currency in 2021.^⁷

Although significant uncertainty persists as a result of the recent discovery of the Omicron variant, we believe the baht is poised to recover some of that lost ground in 2022. Indeed, Thailand reopened to foreign tourists in November 2021, and with the country’s vaccination rate trending higher—roughly 62% of the population is fully vaccinated—mobility restrictions are being lifted and fundamentals are improving. 

• South Korean won: 

South Korea’s economy fared better than most in the region, particularly on the back of record exports. However, we’re mindful the country’s representation in the emerging-market equity index means that the won tends to weaken during periods of underperformance and investor selling, which occurred in 2021. With continued projected strength in the South Korean economy, we believe the won is poised for better performance in the new year.  

Conclusion

Although Asian fixed income experienced faced a trying 2021, we believe the asset class is positioned for better performance in 2022.  

Indeed, the price dislocations experienced in the past year afforded investors a rare opportunity to take advantage of near-term highs in the IG and HY credit spread premium over U.S. credit, as well as idiosyncratic credit opportunities. With increased volatility, and likely further unknowns, however, robust credit research and strict credit selection will remain imperative for investors to take advantage of all Asian fixed income has to offer.

1 Bloomberg. Data is as of December 15, 2021. General Asian credit is represented by JACICOTR (Bloomberg code); investment-grade credit is represented by JACIIGTR; and high-yield is represented by JACINGTR. 2 Bloomberg, as of September 21, 2021.  3 Bloomberg, as of December 16, 2021. 4 Bloomberg, December 6, 2021. 5 Bloomberg, November 1, 2021. 6 Bloomberg. Year-to-date returns are as of December 15, 2021. 7 Bloomberg, as of December 15, 2021.