Accelerating momentum amid a transitioning macro backdrop

Investors entered 2023 with arguably greater certainty than the previous year. The threat of inflation was well known, and it continued to dominate the macroeconomic landscape and monetary policy. Indeed, after the U.S. Federal Reserve (Fed) hiked rates by a historic 425–450 basis points (bps) in 2022, the U.S. central bank delivered a further 100bps of hikes last year, bringing the federal funds rate to 5.25%–5.50% by August 2023. The Fed subsequently paused from September.

However, uncertainty persisted, as investors wondered when the Fed would halt and whether the U.S. economy could ultimately achieve a soft landing. As a result, U.S. Treasuries experienced significant volatility, particularly longer duration bonds. The 10-year Treasury, which began the year at 3.88%, peaked at around 5.00% before receding at year end. The Merrill Lynch Option Volatility Estimate Index, a measure of U.S. Treasury option volatility across maturities, spiked in 2023 to its highest level since 2008.

Against this backdrop (and despite heightened volatility), Asian fixed income outperformed global fixed income and the broader emerging-market universe.

From a credit spread perspective, Asian investment-grade (IG) bonds continued demonstrating resilience, tightening by roughly 32bps in 2023.¹ This was mainly due to the asset class’s shorter duration profile and an investment universe that contains a greater concentration of state-owned firms in more resilient regional economies. IG’s total return grew by 7.4%, driven by solid credit fundamentals and falling U.S. Treasury yields toward the end of 2023.²

Asian high yield (HY) also posted positive returns, albeit at a slower pace of 4.8%, amid the strong performance of regional sectors such as Indian renewables and Macau gaming, offsetting the volatility and adverse sentiment of Mainland China’s property sector.³

2024: yield and carry opportunities remain relatively attractive with a resilient regional economic profile

As we move into 2024, the interest-rate environment is likely to stabilize after the high volatility experienced over the past two years.

Our base case is that the Fed is near or at the end of its current rate-hiking cycle. Once this is confirmed, we believe several positive catalysts will emerge to stabilize the macroeconomic environment and benefit Asia.

Indeed, even as the IMF estimates global economic growth to decelerate this year to 2.9%, Asia is projected to be the fastest-growing global region at 4.2% in 2024 due to its diversified growth profile.

Mainland China’s economic growth lagged market expectations in 2023. Still, we believe that recent signals of strengthening fiscal and monetary policy and more targeted measures to help the property sector,  such as recent reports of a list of developers eligible for financing, are constructive.

Equally important, economies, such as India and Indonesia, have developed new sources of growth that can add to the region’s resilience.

India posted the fastest growth in Asia among large economies in 2023 due to robust government investment in infrastructure and successful manufacturing onshoring schemes such as its Production Linked Incentives. Meanwhile, Indonesia is developing a domestic supply chain to produce electric vehicle batteries that enables value-added activities pertaining to key minerals, such as bauxite and nickel, to remain onshore.

In the next section, we break down our 2024 Asian fixed-income outlook into three areas: credit, rates, and currency. 

2024 IG: continued strong credit fundamentals

Asian IG credit posted resilient performance in 2023 despite a volatile global market due to strong credit fundamentals and robust regional economic growth, which are expected to continue in the new year.

Supply-side factors also played a role: Asian credit issuance declined by 22% year over year in 2023 due to higher yields for U.S. dollar-denominated bonds, which has led many companies to seek cheaper domestic funding options.

Moving into 2024, although we expect lower yields to incentivize a gradual rise in IG issuance, we don’t expect the net supply of bonds to be positive this year (given maturities) unless the Fed embarks on an aggressive rate cuts cycle.

Additionally, although we see some potential spread widening for IG bonds if U.S. Treasury yields continue to move lower, the market’s overall total return should still be positive as declining nominal yields outweigh the loss due to widening credit spreads.

Based on this backdrop, we’re constructive on selective pockets of regional IG opportunities. As always, bottom-up credit selection remains imperative.

• Selective privately owned enterprises (POEs) in Mainland China, primarily with a credit rating of BBB. Although the Chinese economy will likely remain volatile in 2024, we believe that selective POEs with strong fundamentals are poised to outperform and benefit from the country’s structural consumption growth.
• Asian regional bank capital bonds can offer a compelling risk/reward proposition. Indeed, Asian banks have shown resilience after a raft of regional U.S. banking failures in March 2023. Overall, the state-owned nature of many Asian banks augurs well since they’re less volatile and more likely to be viewed as systemically important by governments across the region.
  
  For example, we see opportunities in Indian banks, which are backed by strong economic performance, improving asset quality, and growing demand for corporate and consumer lending. Additionally, we’re constructive on the bank capital bonds of more stable and well-capitalized Australian banks, where we see attractive valuations. By moving down the credit curve, we can obtain higher yields while managing risk among internationally renowned financial institutions with robust corporate governance.
  
  Finally, these instruments also play a key role in portfolio diversification, particularly as overall issuance in the regional IG space has lagged over the past two years.

2024 HY: evolving opportunities in an expanding credit universe

China property continued to weigh on HY performance and investor sentiment in 2023, but as we’ve previously pointed out, the Chinese property sector is playing a less critical role in the HY investment universe as a significant number of firms have defaulted, with some declaring bankruptcy. Since 2021, when the Chinese property sector slump started, 115 defaults totaling US$144 billion have been registered.

We believe the sector will stabilize over the long term amid the continued supportive measures introduced by the government; however, it won’t return to the days when it contributed roughly 25%–30% of the country’s GDP.

Indeed, we envisage that the sector will continue to contract and undergo significant consolidation. The path to this inevitable outcome will likely see continued volatility. That said, the number of defaults is expected to gradually decrease over time.

Perhaps more important for investors, with China property only currently accounting for roughly 5% of the J.P. Morgan Asia Credit Index (JACI) HY (down from approximately 40% at its peak), we expect there are evolving opportunities in a diversifying credit universe. Therefore, further volatility in the sector should have less influence on market performance than larger corporate segments such as Indian renewable energy and Macao gaming.

Furthermore, entering 2024, the credit fundamentals of the overall Asian HY space are expected to improve further. While defaults remain elevated at 12.5% (estimated) in 2023, far above the historical average, they’re forecast to notably decelerate to 10.3% in 2024.⁴

Overall, we're constructive on the following HY segments for 2024:

• Indian infrastructure issuers are attractive, backed by a strong macro story and robust government support. India’s economy is arguably the strongest in the region and the Indian government has earmarked US$120 billion for infrastructure investment in the upcoming fiscal year. This has led to an improving credit profile: Roughly 29% of credit upgrades in India during the first six months of 2023 were related to infrastructure—the most of any sector.
• Macao casinos—Credit fundamentals in this space remained resilient post-Mainland China’s reopening in early 2023. Although economic growth in Mainland China has been slower than expected, Macao’s recovery continued with an uptick in tourists during Golden Week, which led to some credit upgrades. We also see attractively valued opportunities in the sector within the Asian HY space.
• Overall, the landscape of the Asian HY market has changed dramatically over the past three years to become more diversified from a geographic and sector basis.
• The Chinese property sector currently constitutes a significantly smaller proportion of the HY universe than before (roughly 5%). The government has expanded support beyond the supply side (developers) to include the demand side (consumers) in addition to the deep discounts presented in the market. Overall, we’re cautiously optimistic and are highly selective on issuers during this K-shaped consolidation process.

2024 rates: selective opportunities in high-yielding markets

Overall, Asian central banks have varied in their responses to a hiking Fed in 2023: Amid a more benign inflationary environment, some regional central banks, such as those in India and Indonesia, didn’t match the Fed’s pace with continued rate hikes. With the Fed and other global central banks likely on pause and receding regional inflationary pressures in 2024, we believe some Asian central banks have room for potential rate cuts.

As the Asian local currency rate markets have largely outperformed U.S. Treasuries due to a more measured approach to inflation in 2023,⁵ we remain constructive on three high-yielding markets in 2024.

• Indonesia offers an attractive nominal yield, with the 10-year government bond yielding roughly 6.50%.⁶ Further, we believe that Bank Indonesia has potential room to cut rates after hiking its policy rate to 6.00% in October, primarily to protect the currency. Inflation has steadily fallen and remained within the central bank’s target of 4.00%.⁷ Finally, the country’s fiscal situation is improving, with projected fiscal deficits for 2023 and 2024, respectively, both estimated to be lower than the 2.35% posted in 2022.
• The Indian market arguably boasts the strongest fundamentals regionally and offers an attractive 10-year government bond yield of around 7.20%.⁸ Growth remains robust with third-quarter GDP coming in at 7.60% (year over year), which is the strongest in the region, while inflation has receded and the country’s trade and current account deficits have stabilized.
  
  In addition, the market may benefit from potential further inclusion in global indexes: The J.P. Morgan Global Bond Index-Emerging Market suite of indexes will include Indian government bonds starting in June this year, with index providers such as Bloomberg and FTSE also considering the country for inclusion in 2024.

• Finally, the Philippines offers relatively attractive valuation opportunities given its higher volatility profile. The country’s rate environment has displayed historically higher sensitivity to Fed actions; therefore, it could benefit more than other regional markets when the Fed pauses its current rate-hiking cycle.

2024 currency: rupiah and the South Korean won as likely bright spots

The U.S. dollar had a volatile 2023, with the U.S. Dollar Index initially strengthening on the back of higher rate differentials only to end the year roughly flat. Asian currencies posted a mixed performance, with several markets enjoying gains against the greenback in 2023.

We believe signals that the Fed has stopped its rate-hiking cycle will be broadly supportive of Asian currencies in 2024. We’re particularly constructive on two currencies:

• Indonesia’s rupiah is poised for greater stability and performance in 2024 due to an improved global rates environment and potential increases in portfolio and foreign direct investment. Foreign investors currently hold less than 15% of outstanding government bonds. While this was close to 40% before the outbreak of COVID-19 in 2020, this proportion could potentially increase with higher yields and a more stable currency. Foreign direct investment is also accelerating as the country builds a domestic ecosystem to produce electric vehicle batteries and other high-tech products.
• South Korea’s won is also slated to perform after a late-year rebound in 2023. Exports posted year-over-year growth in October for the first time in 13 months after the trough in semiconductor demand passed. With demand for semiconductors and artificial intelligence-related products expected to rise over the near term, South Korea’s exports will likely remain upbeat and contribute to a positive current account in the new year. 

Conclusion

After 18 months of Fed interest-rate hikes and further consolidation in the Chinese property sector, Asian fixed income rebounded into positive territory in 2023 and shows signs of green shoots for 2024.

We believe this momentum can continue in 2024 on the back of a more accommodative Fed, strong regional and corporate economic performance, and resilient credit fundamentals. We believe Asian bond markets have the potential to significantly outperform globally as we move closer to an ending of the Fed’s monetary tightening cycle and bottoming of the Chinese property sector.

However, markets are likely to remain volatile in the interim. In addition to the potential risks over evolving inflation and monetary policy, Asia will experience key elections this year in India, Indonesia, and South Korea—not to mention significant elections outside the region (the United States).

Bottom-up credit analysis remains imperative as credit is expected to remain challenging given that higher rates may lead to slowing economic activity. Selective rate markets and currencies could also contribute to the asset class’s appeal on the back of solid fundamentals.

1 Bloomberg, as of December 31, 2023. 2 Bloomberg, as of December 31, 2023. 3 Bloomberg, as of December 31, 2023. 4 Goldman Sachs, November 24, 2023. 5 Bloomberg, as of December 31, 2023. 6 Bloomberg, as of December 31, 2023. 7 Bank of Indonesia, December 2023. 8 Bloomberg, as of December 31, 2023.