Curve flattening trade in South-east Asia is set to get hotter

LONG bonds in South-east Asia are set to outperform shorter-dated notes as policymakers turn more hawkish, turning the curve flattening trade into a hot bet.

Bond curves in Malaysia, Thailand, Indonesia, and the Philippines are primed for further flattening as front-end yields rise with rate hike expectations while the longer-end, which remains steep relative to many markets outside the region, eases.

While the Treasury 2-and 10-year curve inverted this week, the region's sovereign curves are still steep, even relative to historical averages. Bond curves in other parts of the world have flattened more aggressively due to early rate hikes, leaving South-east Asia to play catch up - and presenting investors with a trading opportunity.

"Front-end yields in South-east Asia are being pressured upwards, as central banks in the region will have to counter inflation which is accelerating rapidly," said Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore. "Evidence suggests that incremental inflationary pressures are already higher in emerging Asia than in the US."

The spread between 2-and 10-year Indonesia bonds is currently around 220 basis points, or 1.4 standard deviations away from the 5-year average gap of 132 basis points. The similar gauge for the Philippines, Thailand, and Malaysia stands at 1.7, 0.7 and 0.6, respectively.

Goldman Sachs Group is among those who expect the rates curve to flatten further in Asia, especially for countries which have been slow to raise rates, as it still appears steep considering the amount of monetary tightening in the pipeline. Persistent inflation surprises on the upside and excessive steepness relative to developed markets and global EM peers will drive this, Goldman Sachs analysts including Kamakshya Trivedi wrote in a note on Friday (Jun 10).

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Last week, the incoming governor of Bangko Sentral ng Pilipinas signalled the likelihood of at least 2 successive quarter-percentage-point hikes. At the same time, Bank Indonesia estimates that June's inflation may exceed its 2-4 per cent price target, which would be the first such occurrence since mid-2017. The Philippine and Indonesia central banks are set to announce rate decisions on Jun 23.

The Bank of Thailand's split decision on Jun 8, which came after May inflation rose to a fresh 13-year high, also suggests the rising likelihood of a rate hike in the near term. As a result, Standard Chartered is expecting an off-cycle rate increase in July, as the next scheduled policy meeting is only on Aug 10, Tim Leelahaphan, a Bangkok-based economist at the bank, wrote in a note on Monday. BLOOMBERG