Fund managers in Asia’s local currency bond markets have one eye on US treasuries and the other on domestic monetary policy. But post-Covid, the correlation has weakened. Inflation is generally less of a problem in Asia; and, since governments in the region did not deploy such massive fiscal stimulus programmes as others did elsewhere, debt-to-GDP ratios are under control. But they are still challenging times for investors.

While the US treasuries market is experiencing what Allianz’s chief economic adviser Mohamed El-Erian has described as an “HFL” moment (when rates are going Higher, Faster and for Longer) as the Federal Reserve tries to tame US inflation, Asia’s central banks are in a stronger position. As Sethaput Suthiwartnarueput, governor of the Bank of Thailand, echoing similar views by other central banks in the region, said during the Thailand Focus event in August: “the pace of the normalization will be gradual and measured … we will continue to be flexible and pragmatic”.

As a result of rising offshore US dollar rates, corporates in Asia are expected to tap into the domestic markets in the coming months. “We envisage a shift to local funding as the cost differential with offshore and foreign currency hedging rates become more compelling for some, particularly high-yield corporates, whose credit spreads are typically wider than those of higher-rated peers,” Fitch Ratings notes in its recent review of rated issuers.

This is supporting a better outlook expectation among local currency investors like Badrish Kulhalli, head, fixed income at HDFC Life Insurance, one of India’s top three life insurers with the equivalent of US$15 billion in fixed income. He shares his cautious optimism about the Indian rupee bond market. While inflation is a concern for India, he points out it is less so than in the developed economies. “The extent of the inflation overshoot compared with the target is greater in Europe, the UK and the US. In India, against a target of 2% to 6%, our inflation is around 7%. So, getting the inflation back to target levels is within sight for the RBI [Reserve Bank of India]."

“At the same time, for now the impact of geopolitical events on energy prices, and thus inflation, has abated slightly,” he explains. “However, we have to see how energy prices move in the coming winter months. Oil is still below US$100 per barrel. So, it is still relatively comfortable compared with the levels seen earlier in the year. But I don’t think this comfort will last if oil prices go back above US$100.”

Vigilance for both the knowns and the unknowns is part of the skill set that makes an Astute Investor. “I don’t think rates are the scariest element at the moment,” observes Prakash Gopalakrishnan, portfolio manager, Principal Global Investors, which invests in several local currency bond markets. “We have seen most of the rate increases already, and we think we are near the topside in terms of treasury yields. The risk markets are generally more of a concern – the known risks of beta in the emerging markets and the unknown risks of what could go wrong. And there it is only left to the imagination. We are having to be cautious navigating the geopolitical issues that are bubbling away – if not at full boil yet – in a low liquidity regime.”

New issues

At the same time, many of the markets are confronted with a shortage of new issues. In India, not only have companies been borrowing less, but banks still have excess liquidity as a result of central bank support during the pandemic and have been lending more to corporates at lower rates than the bond market.

The Malaysian market would also benefit from more supply. “We need more participation from corporates to provide a diversity of choices in our bond market, especially in the AA segment,” explains Hasaliza Binti Hassan, senior fund manager at Etiqa Insurance. “The current issuances are predominantly issued by the government and quasi-government, forming more than 50% of the total outstanding issuances in the local bond market.”

In some respects, Thailand’s problem is different. While there have been new issues, many institutional investors hold the bonds to maturity, so there is very little liquidity in the secondary market.

“In the area of credit paper, there has been a number of new issues with good issuance size in the pipeline,” says Mayura Tinthanasan, fund manager, SCB Asset Management. “The average credit quality is around the A-range rating, which is highly acceptable from a market perspective. Amidst sizeable new issues, the liquidity in the secondary market is yet to be improved as most players tend to participate in primary market book-building rather than trading in the secondary market. In the scope of government bonds, I think there are sufficient new issues and I believe that the Ministry of Finance acknowledges and tries to manage the liquidity issues through a series of on-the-run auction schedule.”

Asset Benchmark Research is pleased to share this year’s ranking of the Most Astute Investors in the local currency bond markets.

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