Asia is likely to return to its pre-covid level of activity earlier than the rest of the world. Guan Yi Low, Chief Investment Officer, Fixed Income Eastspring Investments, believes that Asian bonds offer investors a compelling value proposition now and in 2021.
Following the initial rebound in global economic activity from highly depressed levels in the second quarter of 2020, we expect the pace of improvement to moderate from the fourth quarter of 2020 and going into 2021. At the end of 2021, the output from OECD economies will likely still be 2-4% lower than pre-COVID levels. The spending on goods will slow after the initial burst of pent-up demand has been met. Spending on services, which requires face to face interaction, will continue to struggle. The more immediate risks to growth come from new waves of Covid-19 infection, as well as the fall in household income if the support from earlier fiscal programmes in the developed economies is not extended.
Meanwhile, the US Federal Reserve (Fed) is committed to keep policy rates on hold until the US labour market has achieved maximum employment and inflation averages 2% over time. This implies that the US policy rate will stay at 0-0.25% till 2023. We see the US 10-year Treasury bond yield capped at 1% given the downside risks to growth going into 2021 and the Federal Reserve’s clear policy stance.
Taiwan and China with positive growth this year
Over in Asia, the growth outlook is supported by better management of the Covid-19 pandemic. Taiwan and China, for example, are expected to register positive GDP growth in 2020. Meanwhile, some Asian economies still have fiscal room to provide additional support to counter the demand shock resulting from the outbreak. The relative resilience of the Asian economies, Asia’s subdued inflation and the attractive yield differential between Asian sovereigns and US Treasuries help raise the appeal of Asian bonds.
For example, the China government bond market is one market which offers investors attractive carry and diversification benefits. With China currently accounting for only 6% of the Bloomberg Barclays Global Aggregate Bond Index compared to the higher than 70% weighting made up by US, Japanese and European bonds, there is clearly room for foreign ownership of China government bonds to rise in 2021 and beyond. This is especially so if global central banks seek to diversify their USD holdings over the longer term.
Asian High Yields (HY) should also benefit from investors’ ongoing search for yield. Similar to 2020, we expect default rates to be lower for Asian HYs compared to Emerging Market and US HYs in 2021 – nevertheless active management is still needed to navigate the bifurcated market. While government support in Asia had provided temporary relief to many companies in 2020, further aid may not be forthcoming given already stretched government balance sheets.
On the other hand, the default risk of the Chinese real estate sector, which makes up the bulk of the Asian HY market, may fall. China’s new financing rules require developers wanting to refinance to be assessed against three red lines, or thresholds. These thresholds include a 70% ceiling on developers’ debt-to-asset ratio after excluding advance receipts, a 100% cap on the net debt-to-equity ratio and a requirement that short-term borrowings do not exceed cash reserves. These limits on bank borrowings should help moderate the amount of risk taking within the sector.
Asian currencies – worth a look in 2021
Meanwhile, Asian currencies present interesting opportunities in 2021 and can add to local currency Asian bond returns, particularly against a backdrop where the USD is expected to weaken. With Asia being a relative bright spot amid a pandemic-induced recession, local equity markets (and therefore local currencies) are poised to enjoy liquidity driven inflows. The Chinese Yuan, in particular, should continue to perform strongly, benefitting from a strong current account and capital inflows to its domestic bond market. The New Taiwan Dollar and South Korean Won may be beneficiaries of US-China technology decoupling. The Singapore Dollar should also perform well as a proxy to broad US-Dollar weakness. Meanwhile, high yielding currencies like the Indian Rupee and Indonesian Rupiah can benefit from the global search for yield and carry despite their weaker fundamentals.
Finally, given strong economic growth and government support for better Environmental, Social and Governance (ESG) disclosures, Asia presents a compelling proposition for sustainable investing in the longer term. Existing investments into renewable energy including wind power, hydropower and solar energy, have already led to the emergence of industry leaders in Korea, China and India. In EY’s Renewable Energy Country Attractiveness Index (RECAI), which ranks the top 40 countries in the world on the attractiveness of their renewable energy investment and deployment opportunities, China, India and Japan hold the top spots within Asia. Meanwhile, new renewable investments in Asia Pacific is forecasted to reach USD250 billion by 2025. This suggests that there will plenty of ESG investment opportunities within Asia in 2021 and beyond.
Guan Yi Low
Chief Investment Officer, Fixed Income
Guan Yi Low joined Eastspring Investments in August 2007. Guan Yi is the Chief Investment Officer of the Fixed Income team, responsible for overseeing the management of the firm’s fixed income strategies. She is also the Lead Portfolio Manager for the Asian local currency bond funds.