Why Asia’s equity and fixed income outlook shows resiliency amid a perfect storm

Economic outlooks for Asia in 2022 have been pushed off track by Russia’s invasion of Ukraine. This has sharply exacerbated inflationary pressures that are depressing economic sentiment and raising expectations of more aggressive monetary policy tightening. That, in turn, drives rising recession concerns that weigh on global financial markets.

 

On the flip side, a weaker growth outlook also means fewer rate hikes and less restrictive monetary policy. We would need to see a more sustained market rebound, and a turnaround in inflation, to lead to a pause in the rate-hike cycle and to ease risks of recession.

 

China is the only major economy cutting rates. But Covid and continuing woes in the property sector are complicating attempts to use traditional stimulus tools such as increasing credit supply or cutting interest rates.

 

Asia ex-Japan equity: a multi-track return to normal

 

Asia’s recovery from Covid is key to market stabilisation in the region. This hinges on three interlinked phases. The first is high rates of vaccination to protect populations from severe illness. This feeds into the second phase, in which the level of confidence about living with the virus rises, as demonstrated in Singapore. In the third phase, as the virus becomes endemic, economies will return to normal. That said, we expect this return to normalcy in Asia to be multi-tracked. Countries like Singapore are ahead of the pack, while Hong Kong and mainland China continue to follow dynamic zero-Covid policies.

Asia credit fundamentals have remained largely steady, anchoring the asset class against volatility.

Unlike most of the developed world, further policy easing is on the cards in China as authorities seek to moderate the economic slowdown and stabilise the property sector. We believe this presents an opportunity to surgically select higher-quality issues in the high yield (HY) segment.

Credit fundamentals have held steady despite pressures from rising US and regional rates, and concerns about inflation’s impact on earnings. Given the short duration profile of Asia bonds in general, we think the interest rate trajectory in the US will have minimal impact on the asset class.

Nevertheless, we remain underweight duration. We believe recent volatility in the Asia HY market will subside over the next several months on the back of steady credit fundamentals for non-Chinese issuers. China's Covid-delayed recovery means more defaults are expected in the property sector before stabilisation measures have a wider impact.

This, together with Sri Lanka’s default in May, indicates the expected decline in the Asia bond default rate will be pushed to the first half of 2023 instead of this year.

Meanwhile, some non-China HY credits are benefitting from strong commodity prices and steady credit fundamentals. We continue to favour commodity names as inflation becomes a tailwind for the sector. We expect this strong commodity cycle to last longer due to geopolitical tensions and the reopening of many major economies post-Covid.

The reopening theme is strengthening, with Thailand and Indonesia among the latest investment grade (IG) sovereigns to announce significant relaxation to border measures. Economic momentum broadly remains healthy, with inflationary expectations uneven across Asia.

Flexibility and selectivity will remain the watchwords for the rest of the year. With strong fundamentals anchoring the market, Asia fixed income should offer investors the stability that may be lacking elsewhere.