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LCY markets face liquidity, growth risks
Chito Santiago 1 Dec 2015

The emerging East Asia local currency bond markets are better prepared to deal with impact of a US interest rate hike, but face a pressing need to increase liquidity and broaden the diversity of investor base.

According to the latest issue of Asia Bond Monitor released by the Asian Development (ADB) on November 26, concerns about the rate hike eased for the moment causing the bond yields to decline in recent months. The largely muted inflationary pressures have also contributed to the lower yields.

“The financial markets have been somewhat calmer recently with the US Federal Reserve holding off a rate hike in September, the People’s Republic of China carrying out further monetary stimulus and the oil prices remaining subdued,” says ADB chief economist Shang-Jin Wei. “Overall, the markets are better prepared to deal with any impact a US rate hike may have on another outflow of foreign investment. But risks do remain and there is still a pressing need to increase bond liquidity and broaden the diversity of the investor base.”

The report notes that markets have largely priced in the likely rate hike in December, diminishing the risk that the higher rates would prompt foreign investors to further cut their holdings of East Asian local currency bonds.

However, it cautions that some downside risks remain, including banks cutting back on bond inventories and continued slow growth in the region that put fiscal pressure on governments and reduce corporate profits – both of which could lead to increased risk perceptions, possible ratings downgrades and a rise in yields.

The report adds that yields for 10-year local currency government bonds in emerging East Asia were mostly lower between September 1 and October 31 with the stockmarkets in the region staging a comeback, giving sentiment a lift.

The Philippines saw the largest yield drop of 64bp with China, Hong Kong and Singapore all posting declines of over 30bp. During the same period, most East Asian currencies also appreciated against the US dollar, with the Indonesian rupiah and the Korean won recording the biggest gains of 2.9% and 2.7%, respectively.

In the third quarter of 2015, the outstanding local currency bonds in emerging East Asia rose 5.8% compared with the previous three months and nearly 14.7% year-on-year, reaching over US$8.78 trillion. Local currency bond issuance in the third quarter totaled nearly US$1.6 trillion, exceeding the previous quarter’s US$1.42 trillion with sales led by China and Hong Kong. 

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