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Asia’s markets set to withstand US rate rises
VIEWPOINT – Bond and currency markets have strong fundamentals and look ready to ride the US interest rate cycle comfortably, says Clifford Lau, head of fixed income, Asia, at Columbia Threadneedle Investments.
Clifford Lau 22 May 2017
Clifford Lau is head of fixed income, Asia, at Columbia Threadneedle Investments.
Clifford Lau is head of fixed income, Asia, at Columbia Threadneedle Investments.

Bond and currency markets have strong fundamentals and look ready to ride the US interest rate cycle comfortably.

Asian bond markets are likely to be resilient in response to rising US interest rates, as several of the region’s central banks continue to reflate in order to maintain a trend of stronger economic growth.

They have held up well so far this year, despite widespread expectations of a more hawkish Federal Reserve and amid geopolitical uncertainties following the election of President Trump last November.

This is in sharp contrast to 2013, when even the suggestion by the Fed of higher rates was enough to send emerging currencies crashing and investors rushing for the exit.

Bonds in many of Asia’s developing markets have rallied in 2016 because of negative yields elsewhere. In Indonesia, for example, 10-year government bonds are yielding 7.4%, which is highly attractive compared to Germany’s 10-year yield of -0.107%.

Asian sovereign debt has returned 0.3% during the past 12 months, compared with a 6.2% decline for emerging market government bonds overall, according to Bloomberg data. US dollar-denominated bonds sold by Asian issuers are also showing more buoyancy amid expectations for a pick-up in global volatility, with investors in the region buying more than 75% of new issuance this year and in 2016.

Investor optimism
Recently, the protectionist threats by President Trump induced panic in emerging markets. According to the Institute of International Finance (IIF), investors reacted by withdrawing nearly US$30 billion from emerging market stocks and bonds in November. But the outflow from emerging markets decelerated to just US$1.2 billion in December when the Fed last hiked rates. The IIF estimates that more than US$12 billion returned in January.

In fact, foreign investors have channelled more than US$13 billion into the local debt markets of India, Indonesia and South Korea so far this year, even though the spread advantage over US Treasury yields has fallen as much as two-thirds (in the case of Thai baht-denominated debt) since September.

Overseas investors have bought US$577 million of Indian bonds in the first quarter of 2017, the most since 2015. The country’s debt risk, as measured by five-year credit-default swaps, touched a record low in March. In Indonesia, where foreigners have purchased US$2.2 billion of government debt this year, bond default risk dropped to an almost four-year low at the start of March.

Credit-default swaps on the bonds of every Asian emerging market (except for South Korea) have fallen this year, outperforming debt risk for the UK and for France. Clearly, investors have decided that the world’s fastest-growing region is in a better position to withstand the volatility and outflows triggered by a tightening Federal Reserve.

Robust, if variable, fundamentals
“Strong fundamentals such as high levels of foreign reserves will help emerging East Asia withstand the short-term impact of a likely US rate hike,” commented Juzhong Zhuang, deputy chief economist at the Asian Development Bank.

Improved external balances should cushion any sudden portfolio outflows, while subdued domestic demand should contain inflationary pressures and allow central banks to keep monetary policies accommodative as they seek to preserve what is still an emerging rebound.

Thailand’s exports jumped in the three months to January, prompting the government to forecast the fastest annual growth in five years. Indonesian exports have recovered from an almost two-year slump, and India’s economic growth has hit 6% for the past 11 quarters as Prime Minister Narendra Modi’s reforms take hold.

The IIF says leading indicators suggest that emerging economies grew at an annualised 6.8% in February, following a 6.4% rise in January. By contrast, the International Monetary Fund expects growth in developed markets to be below 2% a year for the foreseeable future.

If confirmed, the IIF forecast would show that the emerging world has broken out of the downward trend that it has experienced since the global financial crisis. In particular, the IIF drew attention to strong growth in hard data, such as industrial production in the likes of South Korea and Singapore, and not just soft data industry surveys. It also pointed to better trade figures, especially from China.

However, the IIF warns that the prospects for emerging economies – even within Asia – are highly divergent. Capital flows have differentiated between countries such as India and Indonesia, which have large domestic markets and economic reform programmes, and smaller, open economies with political problems, such as South Korea and Malaysia.


Clifford Lau is head of fixed income, Asia, at Columbia Threadneedle Investments.

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