Asian credit: Positivity in a negative (yield) world
- Policy rate cuts globally in support of growth have resulted in a sharp jump in negative-yielding debt – totaling 26 per cent of investment grade bonds – and are leading to demand for higher yielding assets. Such an environment is lifting the appeal of Asian credit, given its yield advantage and diversification benefits
- Prospects of continued global monetary easing bias are positive for Asian USD credit spreads. Asian credit, particularly Asian high yield, offers attractive investment opportunities. On a relative basis, the Asian high yield market is offering spread pickup over US and emerging market peers
- Overall credit fundamentals in Asia credit are solid and the default rate is expected to remain stable. The pick up in defaults in the onshore Chinese bond market may cause volatility in the offshore market, but China’s policies are expected to provide adequate liquidity in the onshore market, ensuring effective liquidity transmission to the private sector
- For the HSBC Asian high yield strategy, the ability to navigate both risk-off and risk-on market scenarios has contributed to our performance. Credit selection has been critical to our performance and our strong credit research has helped us avoid poorly performing names
Positivity in a negative (yield) world
Global monetary easing
As we enter the fourth quarter of the year, we are seeing an environment of coordinated monetary easing amongst central banks around the globe. Most recently on 18 September, the US reduced interest rates for the second time this year, as expected by the market, to the target range of 1.75 per cent - 2.00 per cent. The Fed’s policy statement seems to indicate the possibility of another rate reduction in its future path.
The market is pricing in a 65 per cent chance of another 25bp cut this year, while also pricing in a 50bp cut in 2020, which is more aggressive than FOMC views (see Figure 1). For USD credit investors, the risk of policy disappointment from Fed easing should be considered.
Fig. 1: Market expectations lower than FOMC views
Source: Bloomberg, as of 18 September 2019.
The European Central Bank (ECB) has also delivered a monetary easing package in September, which included of a renewed programme of bond buying and a cut in the bank’s deposit rate, amongst other easing measures. In Japan, the central bank had kept policy unchanged at its September meeting, while reiterating its dovish bias and signaling willingness to ease more aggressively should downside risks affect Japan’s economy.
In China, the central bank continued to roll out measures to boost liquidity in the system. On 6 September, the PBoC announced a 50bp reduction in the RRR for all banks effective on 16 September and an additional 100bp reduction in the RRR of qualified city commercial banks to take place in two steps effective on 15 October and 15 November. This marks the second announcement of broad based reduction in the RRR this year and comes on the back of an economic slowdown and ongoing trade tensions with the US. These cuts add liquidity to the banking system and should support lending growth to the private sector.
Monetary policy support in China also came in the form of interest rate reforms unveiled in August, with the central bank linking the new Loan Prime Rate (LPR) to the PBoC’smedium-term lending facility (MLF) rate, which is a better reflection of the funding conditions for banks and can help improve monetary transmission to smaller private firms. While this is an effort to lower funding costs for the economy, we believe further reforms would be needed given certain limitations associated with the new LPR and the market consensus that the reference rate is too high.
Elsewhere in Asia, almost all central banks have already cut rates and have further room to continue their expansionary monetary policies in the face of the latest US Fed move.
Quarter-to-date and particularly in August, financial markets have undergone bouts of increased volatility in the midst of ongoing US-China trade tensions, other geopolitical risks and concerns over headwinds to growth. Such a market has led to demand for safe haven assets and monetary policy easing bias globally, which have resulted in a general shift downwards in bond yields and a sharp jump in negative yielding debt.
Asian credit investment implications
Fund flows to higher yielding bonds
Policy rate cuts globally and the resultant increase in negative-yielding debt –which totals about 26 per cent of global investment grade bonds –is likely to lead to more demand for higher yielding assets. We have seen this by way of strong flows of USD 45 billion year-to-date into emerging market hard currency bond funds, as opposed to the USD 9 billion of flows for the whole year of 2018. The low to negative yielding environment is lifting the appeal of Asian credit given its yield advantage and diversification benefits.
Fig. 2: Sharp jump in global negative yielding bonds
Percentage of outstanding bonds with negative yields in Bloomberg Barclays Global Aggregate index
Source: Bloomberg as of 18 September 2019.
Prospects of continued global monetary easing bias are positive for Asian USD credit spreads. With the recent volatility in the market, Asian credit, particularly Asian high yield, offers attractive investment opportunities, given the spread widening seen in August. On a relative basis, the Asian high yield market is trading at attractive spread levels, offering a spread pickup of 95bp over US peers and 52bp over emerging market peers.
The steep spread differential between high yield and investment grade within the Asian credit market –in contrast to the US credit market where the spread differential is a lot lower –further points to the attractiveness of Asian high yield (see Figure 4).
Fig. 3: Asia high yield trading at a yield premium to other markets
Source: JP Morgan, BAML, as of 31 August 2019.
Fig. 4: Steep spread differential between Asian IG and HY
Spread differential (bps)
Source: JP Morgan, BAML, as of 18 September 2019.
Asian credit as safe haven within emerging markets
The recent sovereign credit upgrades of Indonesia (in May from BBB-to BBB) and the Philippines (in April from BBB to BBB+) by S&P have helped to further solidify the appeal of these markets –and Asian credit in general. As safe haven assets are being sought in this market environment, Asian credit offers global investors the opportunity to invest in higher quality credits, as compared to non-Asia emerging markets, with relatively higher yields. As a result, Asian credit in general is increasingly attracting more developed market investment grade focused investors, thus bringing in a new force of buyers.
Asian credit: Year-to-date strategy review
The Asian USD bond market has returned 9.6 per cent year-to-date (as of 16 September), driven by lower US treasury yields and tighter credit spreads. US Fed movements/market expectations and China’s policy support measures have acted as important drivers for the Asian credit market. JACI has delivered positive monthly returns for every month of 2019 so far. Asian high yield (+10.3 per cent) has outperformed Asian investment grade (+9.5 per cent) year-to-date, while on a quarter-to-date basis, Asian investment grade has outperformed*.
Year-to-date, spreads for Asian investment grade and high yield tightened by 41bp and 68bp respectively (as of 16 September). Spreads reached their lowest levels of the year in early May, and since then (most noticeably in August) spreads have widened out. Following the volatility, valuations have become more attractive, particularly for Asian high yield.
About two-thirds of the Asian USD bond issuance year-to-date has come from China, with a similar trend playing out over the last few years; some of the factors helping ease supply pressure in the offshore market include a slowdown of National Development and Reform Commission (NDRC) quota approvals for USD bond issuance, targeted at property developers and LGFVs, and lower funding costs onshore. Overall, we can expect to see net refinancing fall in 2019 amid heavy maturities.
Fig. 5: Asian USD bonds: net supply decreasing
Source: JP Morgan, as of July 2019
At the same time, the Asian USD bond market this year has also seen a larger proportion of Asian high yield primary issuance versus prior years. Longer dated issuance is also coming to the market, which is helping to spread out debt maturity while lowering refinancing risk.
Overall credit fundamentals in Asia credit are solid and the default rate is expected to remain stable. While there has been an increase in onshore China defaults this year, it is important to note that defaults are occurring mostly in private bonds, which is only a small subset of the market, and the annualized default rate for 2019 year-to-date is still under 0.4 per cent for the onshore China bond market. Given the relatively small size and the limited investor participation of China’s private bonds (that have been defaulting), we do not see much contagion impact; the defaults are not expected to trigger systemic risk. Onshore China bond defaults may cause volatility in the offshore market, but China’s policies are expected to provide adequate liquidity in the onshore market, ensuring effective liquidity transmission to the private sector.
While the situation of US-China trade disputes, along with other geopolitical uncertainties, may dampen risk sentiment, we believe this also increases the appeal of Asian credit, given the region’s solid macro and corporate fundamentals. Additionally, markets of Indonesia and Vietnam are likely to benefit from potential trade diversion.
Asian credit continues to present attractive valuations, higher yields, and shorter duration relative to other major credit markets. Combined with the low correlation of Asian credit to other fixed income markets, the asset class potentially offers good diversification benefits for global investors.
Asian high yield investment opportunities
We continue to take a total return approach when investing in Asian high yield. We prefer the short end of the curve while remaining selective in the long end. In China, we like select high yield property names; the recent market volatility has provided pockets of attractive valuation in the sector. In Indonesia, we continue to favourselect names in the utilities and property sectors as their yields are attractive and fundamentals remain sound. In India, we like select names in the renewables sector and stable short dated industrial names. We are invested in emerging market sovereigns, with some of the exposure likely beneficiaries of potential trade diversion; in addition, we like taking exposure to local currency bonds on a hedged basis to ride on the easing rate trend within the regional markets. We also continue to explore high-yield-like securities issued by stable investment grade names, including bank subordinated debt.
HSBC Asian high yield strategy
The HSBC Asian high yield strategy is top ranked in performance over various periods, ranking in the first quartile (top one quartile) over year-to-date, 1-year, 2-year and 4-year periods (based on Morningstar offshore universe for Asian high yield peers as of 31 August 2019). Our ability to navigate both risk-off and risk-on market scenarios has contributed our performance. Over the past year, credit selection in our Asian high yield strategy has been critical to our outperformance and our strong credit research has helped us avoid poorly performing names.
What sets us apart from peers is our flexibility in our duration strategy, which allows for more active allocation between investment grade and high yield names, in order to best shift positions depending on market environments. Our current exposure to emerging market sovereigns, for instance, has benefited us in a market where emerging market flows have been constructive. Another such example is our exposure to investment grade names, which is higher than some of our major peers. We also continue to produce diversified sources of alpha, including from our duration strategy, curve positioning and currency exposure.
For the rest of the year, we expect to see increased divergence in the market and greater efficiency in pricing of credit risk. As we move into the later stages of the credit cycle, we continue to believe in prudent credit selection. Relative value strategy supported by solid credit research should be key to outperformance in the current market environment.
Fig. 6: HSBC Asian high yield strategy against peers
Comparison is based on select peers within the Asian high yield universe of peers. Source: Bloomberg as of 17 September 2019
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