Bond investors foresee year of calm, not tantrums

Bond market investors in Asia are taking a sanguine approach to the prospect of a rise in US interest rates this year, believing a repeat of the so-called “taper tantrum” is unlikely.

Asia and emerging markets suffered huge capital outflows as soon as the-then US Federal Reserve chairman, Ben Bernanke, first raised the possibility of tapering its bond-buying programme in May 2013.

But with largescale US asset purchase having been completed last October and a consensus in the market that US rates will rise in the second half of this year, there is little discernible fear for 2015.

Desmond Soon, Singapore-based co-head of investment management for Asia ex-Japan at Western Asset, told AsianInvestor that reforms in Asian emerging-market (EM) countries such as India and Indonesia, hardest hit by capital outflows, would prevent a repeat of the incident.

“Because of the learning experience, adaptive expectations and macro policy changes ... I think the impact on better-prepared EM countries from the US [interest rate] lift-off will look quite different from the taper tantrum situation," he forecast. "I think the reaction will be less.”

India and Indonesia both elected reformist leaders last year and also have higher interest rates than at the time of the tantrum in 2013.

Kevin Anderson, head of Asia-Pacific investments for State Street Global Advisors, has suggested that US interest rate increases are likely between June and September this year, with none expected in Europe and Japan where accommodative monetary policies appear set to continue.

But Threadneedle Investments stated in a report last month that it does not expect to see a bond market rout in 2015, despite the unappealingly low government bond yields in some countries such as Japan and Germany.

Its confidence is grounded in subdued inflation expectations and a belief that major developed-world central banks will not aggressively tighten policy this year.

In addition, Threadneedle sees a more fundamental constraint on sovereign yields. "Many governments now have so much debt that they simply would not be able to tolerate a big increase in their cost of borrowing,” the firm stated in a report last month.

Western’s Soon sees a possibility of Asian sovereign bond yields falling further this year, with economic weakness exerting downward pressure.

"There is still scope for longer-dated sovereign bond yields to go down even if you have a lift-off in US rates in the second half of this year, which is kind of contradictory because most people expect, given that US rates will start to lift off, bond yields in Asia will rise in tandem," he explained. "But I think the long-end is going to be well anchored by weaker economies and disinflation.”

This could lead to wider credit spreads this year – even among developed countries there are big differences, with Japanese and German 10-year yields around 0.4%-0.5%, compared with similar dated US Treasuries yielding around 2%.

In the corporate bond world there is not the same level of confidence, especially when it comes to deeply indebted companies in China. The slowing economy, tight liquidity and steep decline in energy prices is “throwing out a lot of companies that are overleveraged and in the oil and gas sector,” according to Soon.

However, the experiences of 2014 should perhaps make investors wary of making predictions. Last year saw unexpected geopolitical turmoil such as revolution in Ukraine and student-led protests in Hong Kong, which precipitated a flight to safety among investors. This benefited sovereign bonds, observed Jim Leaviss, head of retail fixed interest at M&G Investments.

"With substantial volumes of QE still on the horizon in a number of globally significant economies such as Japan and the eurozone, the prospect of deflation rather than inflation keeping central bankers awake at night, and the timing of interest rate hikes being pushed out in nearly all economies, it does not need a huge leap of faith to say that conditions for bond investors currently look relatively benign,” he observed.

But as he pointed out, given the experience of last year, a few dramatic months in 2015 could easily blow early-year estimates off course.