Emerging Asia bonds draw global funds despite Fed hike fears

[SINGAPORE] Foreign investors are piling back into Asian emerging-market bonds despite renewed Federal Reserve hawkishness, as expectations that regional central banks will keep interest rates elevated support the debt’s yield appeal.

Combined inflows into Thailand, Indonesia, India and Malaysia climbed to an over two-year high of US$8.2 billion in June, according to data compiled by Bloomberg. That has helped a broader gauge of local-currency emerging-market notes outperform peers in Europe, Middle East and Africa as well as Latin America since the US and Iran agreed to an interim peace deal.

While oil prices slumped back to pre-war levels following the agreement in mid-June, analysts still see Asian central banks maintaining a hawkish bias as underlying inflation remains resilient. Strategists say the region’s policy outlook should continue to underpin demand for local-currency debt, even as traders in the fed funds market ramp up bets on Fed hikes with some seeing it as soon as July.

“The recent hawkish turn by emerging Asia central banks has created a degree of immunity for their local markets, and we maintain our constructive view on emerging Asia local-currency bond performance over the next few months,” said Homin Lee, a senior macro strategist at Lombard Odier Singapore.

A Bloomberg index of emerging-Asia bonds is up 0.2 per cent since the US-Iran deal. A similar gauge for Europe, Middle East and Africa is little changed while an index for Latin America has fallen 0.6 per cent. A hawkish Fed leading to a broad tightening in financing conditions would affect countries that rely more on foreign capital, such as Turkey and Colombia, according to Fidelity International.

Asian notes are also showing relatively less sensitivity to moves in Treasuries. The 30-day correlation between five-year US and similar-dated emerging Asia yields is around 0.04, versus 0.34 for EMEA and 0.44 for Latin America.

“We remain constructive on emerging Asia local-currency bonds, supported by easing energy-related risks and relatively attractive valuations,” said Peerampa Janjumratsang, a portfolio manager for fixed income at M&G Investments in Singapore. “However, performance is likely to remain uneven, reflecting country-specific dynamics and differing exposures to global growth and inflation drivers,” she added.

That said, the fragile US-Iran truce remains a key risk. A lasting easing in tensions could keep oil prices contained and give Asian central banks more room to lower interest rates, while renewed conflict would likely reverse those gains. Separately, a more hawkish Federal Reserve could still sap demand for emerging-market assets globally, including in Asia.

Investors will be watching the release of US nonfarm payrolls on Thursday for validation on market pricing for the Federal Reserve, after chairman Kevin Warsh said on Wednesday that inflation expectations had moderated over the past month.

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Thailand, Taiwan, the Philippines and China are among markets due to release inflation data in the coming days, giving investors fresh clues on whether price pressures are accelerating or easing. Malaysia’s central bank is also scheduled to announce its rate decision on Jul 9.

For some money managers, a constructive outlook for emerging Asian currencies is adding to the appeal of the region’s local-currency bonds.

A quarterly survey by HSBC Holdings published on Jun 22 showed investors were more bullish on emerging Asian currencies than those in any developing region except Latin America.

The poll of 101 investors overseeing US$432 billion of emerging-market assets found net bullish sentiment towards Asia at 13 per cent over the next three months, signalling that a greater number of investors see a more favourable outlook versus a less favourable one.

“The main transmission channel from a more hawkish Fed would be through currencies which could then affect local bond pricing,” said Ward Brown, a fixed income portfolio manager at MFS Investment Management.

Currencies from parts of Central Europe and Latin America “would likely be more vulnerable” due to dovish central banks and less robust external buffers, while Asian currencies are more resilient as “many Asian economies maintain stronger external balances,” he said. BLOOMBERG