Mid-Year Outlook: Policy Easing Supports Asian Bonds

The first half of this year has been a story of resilience, with emerging market stocks and bonds recovering from 2018’s dip and delivering better-than-expected returns. In particular, Asian local currency government bonds recorded a total return of 4.7% in US dollar terms*, as measured by Markit iBoxx Pan Asia Bond Index, in the first six months of 2019.

Looking ahead, Asian bonds are expected to stay well supported on the back of moderate growth, low inflation and easing monetary policy stance by the central banks. Meanwhile, the decline in the US dollar should support Asian currencies in the near term. However, downside risk could increase if trade war tensions escalate.

ECONOMIC GROWTH COULD WEAKEN

Weaker global trade flows in 2018 hurt global economic momentum and reined in growth projections for 2019. Now, halfway through the year, the threat of a protracted US-China trade war has weighed on the US economy. In Europe, insipid growth in certain countries and a lack of clarity on the future of the UK-EU relationship could dampen its economy.

This overall slowdown means a decline in demand for Asian exports that, when coupled with weaker domestic markets, signals a likely softening of economic growth in the region. Recent data indicates that growth is likely to remain subdued. Demand for exports is weighed down by weaker global demand and a shift in the electronics inventory cycle. Manufacturing purchasing manager index (PMI) numbers, which are widely considered forward-looking indicators, are also likely to be dragged by falling new export orders due to uncertainties arisen from the unresolved US-China trade war.

China’s economy continues to decelerate as it goes through a period of rebalancing. In addition, with the latest manufacturing PMI numbers falling into contractionary territory, we expect China to introduce more domestically focused fiscal stimulus measures to help boost growth in the coming months. We expect China’s economy to grow at around 6% this year.

DOVISH ASIAN CENTRAL BANKS JOIN THE FED

With the US Fed now indicating prospect of slower US growth thus increasing market expectations for monetary easing, Asian central banks are expected to maintain dovish monetary policy stance given benign inflation and slowing growth. 

Central banks in the Philippines, Malaysia and India have started to cut rates a few months ago to bolster their economies against an escalating trade war. While we expect Bank Negara Malaysia to be on hold following a cut in policy rate in May, the monetary easing bias in the Philippines is likely to continue after the central bank surprised the market with a pause in June. Most recently, the Bank of Korea surprised the market with its first interest rate cut, citing headwind to external demand, tech sector slowdown and concerns related to Korea-Japan trade dispute. Subsequent comments from the central bank indicate that a dovish stance would be maintained going forward. Bank Indonesia also joined in the foray to make its first interest rate cut just recently as widely expected against the backdrop of slowing economy and subdued inflation. The recovery of Indonesia’s rupiah also creates more policy room for the central bank to lower interest rates in the coming months.

BOND YIELDS MAY DIVERGE AROSS THE REGION

However, should the US-China trade dispute worsen, bond markets in the region could have a mixed outlook. While we envisage falling rates in countries such as Korea, a potentially negative outcome from the trade dispute could drive yields higher in other Asian countries. A worsening US-China trade spat would not only hurt growth, but also harm emerging market sentiment and currencies.

Deteriorating external conditions would put pressure on countries with high current account and budget deficits. The bond markets in, for example, Indonesia and Malaysia, would likely face outflows and hence rising rates if markets turn to risk aversion mode because of rising trade tensions and weakening currencies. Malaysian bonds may be further affected by the potential exclusion from the FTSE World Government Bond Index later this year. On the other hand, Thai bonds may be supported by the ongoing political uncertainty and Chinese bonds may benefit from policy easing measures.

TRADE DEVELOPMENTS TO DETERMINE THE OUTLOOK

At the mid-point of 2019, we seem to be in a binary situation where the outcome for the rest of the year is dependent on how the US-China trade dispute develops. If a deal is reached between the two economic powerhouses later this year, the potential for modest economic growth over the next 6–12 months remains likely. Fed policy should remain accommodative to boost the economy, and the positive effects of China’s fiscal stimulus could gain momentum.    

If trade tensions persist, they are likely to have a damaging impact on global growth and emerging market sentiment. Central banks will be ready to ease policy, however, we expect Asian bonds to be mixed as yields in some countries could still rise on the back of weakening currencies. 

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