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Treasury & Capital Markets
How LCY bond yields diverge amid global uncertainty
While yields in advanced economies largely rose between December 30 2016 and February 15 this year, those in most emerging East Asia economies have trended downward despite the risk of an accelerated pace of interest rate hikes in the US.
Chito Santiago 22 Mar 2017

Yields in local currency (LCY) government bonds have manifested divergence amid the heightened global uncertainty. While yields in advanced economies largely rose between December 30 2016 and February 15 this year, those in most emerging East Asia economies have trended downward despite the risk of an accelerated pace of interest rate hikes in the US.

Amid the solid growth and rising inflation, investors across most of the region have demonstrated heightened confidence in emerging East Asia LCY government bonds, resulting in declining yields, as noted in the latest issue of Asia Bond Monitor released by the Asian Development Bank (ADB) on March 22.

Indonesia’s implementation of sound reforms underpins the largest decline in yields over the period with yields for two-year bonds dropping 48bp and 42bp for 10-year bonds. Indonesia benefited from improving investor sentiment buoyed by a narrowing current account deficit in the fourth quarter of 2016, an upgrade in sovereign rating outlook from Fitch Ratings and Moody’s Investors Service, rising international reserves, and various policy reforms initiated by the government.

Singapore recorded a decline in yields of 10bp for two-year bonds, and 23bp for 10-year bonds, while Malaysia also posted a drop in bond yields due to strong demand from local investors despite a rise in inflation.

China, on the other hand, saw yields for two-year and 10-year government bonds go up by 9bp and 48bp, respectively, as the People’s Bank of China engaged in tightening measures to protect against asset and credit risks.

All of the region’s currencies appreciated against the US dollar, except for the Hong Kong dollar and the Philippine peso. Equity markets also rose in the region.

“Emerging East Asia’s improved growth outlook and strong fundamentals have buffeted the region from risks of possible capital outflows,” says ADB chief economist Yasuyuki Sawada. “Policies to improve the transparency of financial markets and encourage long-term investment can help countries face future external shocks.”

As at end-2016, the size of emerging East Asia LCY market amounted to US$10.177 trillion, with growth moderating on both a quarter-on-quarter and a year-on-year basis. Government bonds continued to dominate the market as they accounted for US$6.572 trillion, or 64.6% of the regional total, while corporate bonds contributed US$3.605 trillion. Total issuance in the fourth quarter was down 14.8% quarter-on-quarter to US$946 billion due to contraction in the issuance of government bonds, which offset the increase in issuance of corporate bonds.

China remained the largest LCY bond market in emerging East Asia with outstanding volume of US$7.129 trillion – or 70% – as at the end of 2016, followed by Korea with US$1.714 trillion (16.8%). They were followed by Thailand with US$303 billion, Malaysia US$260 billion, Hong Kong US$236 billion, Singapore US$230 billion, Indonesia US$163 billion, the Philippines US$98 billion and Vietnam US$44 billion.

The share of foreign holdings in most emerging East Asia markets slipped in the fourth quarter of 2016 due to a stronger US dollar and expectations of accelerated US interest rate hikes in 2017.

The largest decline was noted in Malaysia where foreign investors’ holdings fell by more than three percentage points to 32.2% at the end of December 2016. A similar trend was registered in Indonesia where foreign investors’ holdings fell by 1.6 percentage points to 37.6%.

In both markets, a large share of government bonds is held by foreign investors, making them susceptible to capital flights during market sell-offs. ADB says this was evident during the fourth quarter of 2016 when volatile financial market conditions persisted and the foreign holdings’ share in Indonesia and Malaysia declined more rapidly than in regional markets with lower foreign stakes.

At the same time, though, ADB notes the two markets were not severely affected by these outflows as demand from domestic investors remained strong. Further, market players have already priced in more aggressive rate hikes by the US Fed in 2017 and the sell-offs tend to be short-lived. In January this year foreign investors shored up their holdings of Indonesian government bonds with their share rising to 37.8% of the total.

In another market, foreign investors’ holdings in Thailand fell to 14.1% as at end-December from 14.8% in September.

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