This year began with a focus on three key themes – slowing global growth, ongoing US-China trade tensions and the imminent tightening of the US Federal Reserve’s (Fed) monetary policy. Fast forward to November and this narrative continues to feature prominently in markets – with one significant exception being the shift in the stance of global central banks from a hawkish to a more dovish bearing and the resumption of lower for longer theme. Sounds like deja vu but this time round Asian central banks are getting close to their historic lower bound of interest rates.
Extended trade tensions take a toll on growth
At the end of 2018 markets were preparing for softer global growth on the back of the continuing trade conflict between the US and China. An expected slowdown in exports meant that Asian economic expansion was also forecast to soften. Since then, markets have experienced bouts of volatility in part due to the escalating risks of a trade war, as both the US and China engaged in a tit-for-tat dispute, applying tariffs on billions of dollars’ worth of goods from each other throughout the period. However, negotiations between the two economic giants have made some progress. The latest round of talks in October ended with the US President Donald Trump announcing that China has agreed to a “very substantial phase-one deal”.
Despite this development, the risk of a prolonged trade war remains in play for markets. The International Monetary Fund (IMF) cited it as a key reason for cutting its 2019 global economic growth forecast to 3%, from a 3.2% prediction in July. In the US, although first-quarter growth was not as bad as predicted, the ongoing trade fight slowed down second-quarter GDP to 2%. China was also hit, not only by higher US import tariffs but also slowing domestic demand. It reported a 26-year-low growth figure of 6% for the third quarter, down from 6.2% in the second quarter. The IMF revised down its projections for almost every major market, including Hong Kong, South Korea and Singapore.
Predictions for global growth
2019 welcomes a new wave of monetary easing
The growing risk of a trade dispute and the rise of unexpectedly weak data – including the inversion of the US Treasury yield curve, which raised concerns of a recession – changed the tone of global policymakers. In December last year, markets were preparing for a gradual end of stimulus policies. However, within the first quarter itself, the Fed put rate hikes on hold, and the European Central Bank (ECB) followed its lead, signalling that interest rates would stay at record lows for longer. In July, the Fed delivered its first rate cut since 2007, followed up with a second cut in September and the latest rate cut at the end of October. In September, the ECB took rates further into negative territory, with the deposit rate cut to -0.5% from -0.4%, and announced a restart of its bond-purchase programme in November.
Asian central banks, which at the start of the year had been forecast to hike rates to support weakening currencies or tackle inflation, also joined the movement to shift to an accommodative policy stance. In August, the central banks of Thailand, India and New Zealand announced surprise rate cuts, while the Bank of Indonesia delivered another unexpected rate reduction – its second one in two months. More recently, the Philippines and South Korea have also followed suit, while the People’s Bank of China trimmed its reserve requirement ratio by 50 basis points.
Asian bonds in focus as negative-yielding debt pile grows
A slowing economy has pushed down bond yields across the world, so much so that now $17 trillion of bonds offer negative yields, compared with $8.3 trillion at the end of 20181. However, this provides a strong backdrop for Asian bonds, which continue to offer a positive and higher yield compared with their peers. Adding to this is expectations for further easing from the Fed, which is supportive of bonds and currencies in this region, while a dovish stance from Asian central banks can boost local fixed income markets.
Higher yields on offer in Asia relative to developed world
Another factor likely to drive demand for this asset class is the long-term favourable market development. The Asian bond market is simultaneously becoming more liquid and maturing – earlier this year (and until the end of 2020), China reached a milestone as the process of adding onshore Chinese bonds to major fixed income indices began, a major step to integrate the market with the broader universe of global fixed income. On the back of Bloomberg Barclays bond indices including China bonds into their major indices earlier this year, JP Morgan also announced that their major bond indices will start to include China bonds at the end of February in 2020.
While headwinds remain, including the possibility of a negative outcome from US-China negotiations and rising political risk in some Asian countries, we believe that the softening global economy will maintain investors’ hunt for yield and Asian bonds are likely to play a vital role in the solution.
Visit www.abf-paif.com* for our latest insights and investment ideas for Asian fixed income.
1 Source: Bloomberg, as of 30 August 2019.
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