16 November 2022

2023 Asia ex Japan Fixed Income Outlook: Seeking the Right Risks

Author:

  • Despite growth headwinds in China, emerging policy support from Beijing and across Asian economies will keep inflation under control and ensure regional GDP remains solid amid a continued reopening-led recovery.
  • Going into 2023, we believe the market is offering a rare opportunity to produce alpha by selectively adding credit exposure in both the Asian investment grade as well as the high yield markets. In short, we believe next year will reward credit selectors.
  • Asian investment grade offers pent-up performance given higher yields and strong fundamentals.
  • A defensive stance in Asian high yield reflects uncertainty over the immediate future of China’s property market, although attractive opportunities are emerging in other sectors elsewhere in the region.
  • Returns from Asian local currency bonds remain suppressed, but as the US dollar weakens in 2023, bonds denominated in Singapore dollars and Thai baht should perform better next year.
2023 Asia ex Japan Fixed Income Outlook: Seeking the Right Risks

After finally emerging from a world-changing pandemic, economies and markets have been subject to an array of headwinds: more persistent inflation than expected, rising policy rates, war-induced supply chain and energy security disruptions, and escalating geopolitical tension. As a result, a global economic slowdown is looming. Sizable and front-loaded monetary policy hikes to tame inflation in much of the world, led by the US Federal Reserve, are fueling growth concerns.

The expected slowdown will last for much of 2023, if not longer. Yet it is largely priced in, especially in some pockets of the credit markets. Investors can also potentially lock in higher yields, which have historically boosted returns for bond portfolios over time. In a nutshell, fixed income markets offer much more value at this point.

We see significant scope for selective allocations and some careful risk-taking by Asia fixed income investors. Total returns are there for those who can navigate the markets and a still challenging macroeconomic environment.  

Performance is building up but we expect return dispersion will persist.

Asia’s growth outlook: Slower but not alarmingly so

Asia looks relatively well-positioned in a global context. Subdued and largely manageable inflationary trends within many local economies will likely create a backdrop for monetary policy to move closer to neutral without being overly restrictive, with the possible exception of countries such as South Korea and Singapore.

Our regional GDP forecast reflects this. Generally, we expect a sound growth outlook as Asian countries enjoy a much-delayed and much-needed reopening-led recovery.

These economies will get a turbo charge sometime in 2023, when we expect China to gradually and cautiously ease its zero-Covid policy. While the timing is difficult to pinpoint, we expect it to occur within the first half.

More measured monetary policy hikes

Monetary policy in much of Asia has followed or preempted the Fed’s. Critically, however, Asian central bank moves have generally been much less aggressive, and we expect this trend to continue. To start with, monetary policy was not as accommodative as that of the major developed market central banks. The monetary policy U-turn is therefore less extreme. Additionally, while inflationary pressures exist in Asia, they are relatively subdued, and we expect headline inflation to peak by the end of the year in most Asian economies. Our base case is that monetary policy will move closer to neutral but not into restrictive territory for most Asian countries. India, for instance, continues to see credit growth and real estate growth despite recent rate hikes.

Moderate Rate Hikes in Asia

Moderate Rate Hikes in Asia

Source: PineBridge Investments, as of 31 October 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

The rate hikes have, unsurprisingly, contributed to the weakening of Asian currencies, pushing returns on local currency bonds down. This will have an impact on the issuers’ debt servicing ability. Our analysis shows that this will not be across the board, however, especially given that we expect the US dollar’s strength to subside next year.

With many factors creating external pressure in 2022, we are carefully monitoring whether capital flows can fund the basic balance deficits. This depends on nominal rates, growth differentials, and global risk appetite. As such, we expect the situation to differ across markets. Thailand, for instance, which has a much less hawkish central bank, is exposed to this vulnerability, although we think its economic recovery and hence external funding situation will improve, particularly as it reopens for tourism. The Philippines, with its hawkish central bank, and India, with its relatively low foreign ownership and capital flow restrictions, will be less exposed. Frontier economies will be at the mercy of risk appetite, especially given that some of them have sizable external debt maturities.

Still cautious on China's near-term growth outlook; significant return dispersion expected

Unsurprisingly, China will play a determining role in shaping Asian fixed income markets.

For the first time in decades, China’s economic growth is forecast to lag broader levels across Asia this year. As a result, Beijing has kick-started a cycle of selective policy easing. This will translate into higher investments into infrastructure, with the aim of spurring growth.

China is one of the few countries today that has an accommodative monetary policy stance and is increasing support to its economy. That said, it’s important to highlight that these measures have been targeted, incremental, and highly selective. We do not expect this approach to change but we do expect stronger policy support. In short, China’s bias is to support its economy, but do not expect any major announcements.

These measures are much needed to offset a struggling property sector that is not yet showing signs of improvement, despite some policy backing. We expect that segment to remain challenged, although the trend may start to improve in the first half of 2023. This rather limited policy support has led some foreign buyers to reduce their exposure to China, both onshore and particularly in the Asia high yield market. We do not expect that trend to change anytime soon.

Chinese policymakers will take steps to ensure systemic risk remains well contained. This is supportive of the key state-owned enterprises (SOEs), which have deleveraged in recent years and are playing important policy roles in the current economic transition. However, we maintain a defensive posture within China credit positioning. The magnitude of policy support remains insufficient for the weakest credits, while the highest-quality credits are benefiting from cheaper funding access. We expect the credit spread differential between private companies and SOEs to remain elevated until there is more clarity about policy support to the former and a major shift in the zero-Covid policy.

Divergence Between China Onshore and Offshore Yield

Divergence Between China Onshore and Offshore Yield

Source: Bloomberg, WIND, and PineBridge Investments as of 31 October 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

Positioning in 2023

Going into 2023, we see significant opportunities in the key asset classes in Asian fixed income.

US dollar-denominated Asian investment grade

We think Asian investment grade (IG) bonds provide compelling risk-adjusted returns, with higher yield and shorter duration than similar high-quality bonds in other regions. This makes the asset class a strong diversifier for global fixed income investors.

Asia's Duration Is Shorter Than Peers', With Better Yield

Asia's Duration Shorter Than Peers', With Better Yield

Sources: Bloomberg, PineBridge Investments as of 11 November 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

We believe three factors will continue to support Asia IG in 2023:

Solid fundamentals. Despite increased government spending for Covid relief and inflation threats to earnings, Asia IG fundamentals have remained broadly strong. Corporate earnings in Asia ex Japan have generally been revised upwards, in contrast to the declining trend in the US. Export earnings have been strong, and a stronger dollar could offer support for exports to grow further. Moreover, any funding cost pressures for corporates are partly met by local debt market access. China’s onshore corporate bond yields in particular continue to tighten, supporting China investment grade issuers’ access to cheap funding.

Supportive technicals and lower volatility. We expect net negative supply for 2022 and 2023, potentially pushing up values amid pent-up demand. The market’s size is holding steady at close to US$1 trillion.  The relatively lower volatility of the market is credited to a dominant Asian institutional investor base that tends to hold a long-term view of their investments.

Attractive valuations. The Asian IG market has higher yields and spreads than similar markets, but with a shorter duration, making it less interest rate sensitive. The valuation is the most attractive it has been since the Great Financial Crisis.

Asia high yield

Understanding the components of the Asia high yield market is key to navigating the credit challenges in this asset class. Following the series of defaults in China’s property sector, the sector’s weighting in the Asia high yield index has shrunk significantly, to 8.3% of the JACI HY index currently from 35% in mid-2021. While the property sector will continue to dominate headlines, its impact on Asia high yield will be much lower going forward and highlights the improved industry diversity of this market. At the same time, Asia high yield corporate default rates have stayed relatively low outside of the China property segment. According to JP Morgan estimates, while China property sector default rates are staying elevated, the Asia high yield (ex-China property) default rate will be 0.9% in 2022 and an average 1.8% in the past 10 years, compared to a US high yield corporate default rate at 1.5% in 2022 and an average 2.4% in the past 10 years. For 2023, the Asia high-yield (ex-China property) default rate is expected to remain low at 1.5% versus US high yield at 2.3%, given manageable refinancing risk.

US vs. Asia (ex China Property) Historical Default Rate

US vs. Asia (ex China Property) Historical Default Rate

BofA ICE Index

BofA ICE Index

Sources: Top: JP Morgan, PineBridge Investments, as of 31 October 2022. Bottom: BofA ICE Index, PineBridge Investments, as of 11 November 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change.

Any significant loosening of China’s Covid policy could be very positive for certain high yield sectors, such as gaming – particularly for Macau, which has yet to clear pandemic obstacles. Notably, we are now seeing promising opportunities emerge beyond Chinese property, including renewables, short-dated commodities, and segments benefiting from post-Covid reopenings, such as airports. Valuations in these sectors have become attractive partly due to the spillover of China’s property sector.

In sovereigns, the outlook remains challenging for frontier markets such as Sri Lanka and Pakistan. We’ve taken a more defensive approach to non-investment-grade sovereigns.

Asian local currency bonds

Based on our view that the US dollar’s strength will subside in 2023, we expect Singapore dollar bonds to outperform, given the hawkishness of the city-state’s central bank.

We also believe the reopening theme in Thailand will bode well for Thai baht bonds following a recovery in tourism, in turn helping to bring the country’s current account back to surplus.

Elsewhere in Asia, we expect to see several underperformers: firstly, the Philippine peso, given the current account is expected to reverse due to higher investment-led imports; secondly, the South Korean won, with high beta to tech stocks and global growth; and thirdly, the Indonesian rupiah, due to valuations and current account deterioration.

Key takeaways

While we expect the macroeconomic environment to be more challenging in 2023, we think some pockets of the market are ripe for strong performance in ways unseen since the Great Financial Crisis. That said, we are calibrated in our credit selection and expect the return dispersion of 2022 to persist in 2023. Asia investment grade, the biggest segment of the Asian bond market, is expected to see strong interest due to its reasonable yields and high credit quality. Concerns about Asia high yield may persist for some time, driven by extreme volatility and distress in China’s property sector. This, however, should not obscure opportunities in the broader Asia high yield market, especially since default rates remain relatively low. We also expect some local currency markets to perform better next year, especially in Singapore and Thailand.

Positioning for more sustainable bond returns

The growing desire among investors to develop and achieve sustainability objectives was tempered to some extent in 2022 amid rising interest rates and increased capital market volatility. The upshot has been a decline in ESG-labeled bond issuance in the past few months.

According to Sustainable Fitch, for example, green bond issuance dropped by 21% in the third quarter of 2022 compared with the second, while sustainability-linked bond (SLB) issuance was down 62% quarter-on-quarter to US$7.9 billion. Corporate issuers, typically dominant in the SLB space, dropped to 4% of the total sector, down from 24% a year earlier.

This trend followed the year-on-year decrease witnessed in green, social, sustainability, sustainability-linked, and transition (GSS+) labeled debt in the first six months of 2022, according to the Climate Bonds Initiative. Its data showed a combined volume of US$417.8 billion in the first half of the year, which was down 27% against the same period in 2021.

Such data shouldn’t be surprising. Not only has it been a challenging year for global bond markets generally, but accelerated buying of ESG-linked debt since Covid has been exceptional.

Moreover, sovereigns, supranationals, and agencies have proven to be innovators. For example, Singapore sold its debut long-dated sovereign green bond in 2022, and the Hong Kong government had issued green bonds worth US$10 billion in the past few years as of August 2022.

Important regulatory developments will also foster more activity. In Hong Kong, the Securities and Futures Commission’s new ‘Agenda for Green and Sustainable Finance’ sets out steps to enhance corporate disclosures and monitor the implementation of measures relating to ESG funds. In Singapore, progress is being made across the finance sector to implement the Monetary Authority of Singapore’s guidelines on environmental risk management, which is an essential step to meet increasingly detailed regulatory requirements on environmental risk management.

Going forward, therefore, we expect the need – and appetite – for green finance and socially-focused projects to attract increasing capital from Asian fixed income investors, with ESG bonds to account for an increasing proportion of overall issuance.

For more investing insights, visit our 2023 Investment Outlook.


Disclosures

Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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