Emerging market bond laggard Asia is primed for rebound in 2023

EMERGING Asian bonds have trailed their developing-nation peers this year, but a turning point looks to be just around the corner.

Inflation pressures have begun to ease in many parts of the region, bringing forward predictions for a peak in interest rates. At the same time, positioning from overseas investors is historically light, leaving plenty of scope for inflows to increase. Finally, there’s growing optimism over an economic recovery in China into 2023, despite uncertainty over an increase in Covid protests.

Those positives are paving the way for a change in fortunes compared with the second half of this year, when emerging Asia bonds lagged their global counterparts on the perception that Asian policymakers had been too slow to raise interest rates compared to their global emerging market (EM) peers, especially those in Latin America.

“For emerging-market Asia bonds in general, I think it will be a brighter six-to-12 months ahead into 2023 following two tumultuous years,” said Winson Phoon, head of fixed-income research at Maybank Securities in Singapore.

The market is getting better visibility on the terminal Fed funds rate and on the potential need for regional central banks to slow down on tightening, while “the tide on bond positioning may be turning favourable”, he said.

Emerging Asian bonds have handed dollar-based investors a loss of 2.8 per cent since the start of July, according to an index compiled by Bloomberg. That compares with a drop of 0.4 per cent for their counterparts in Europe, the Middle East and Africa, and a 1.6 per cent gain in Latin America.

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Easing inflation

The main reason for optimism towards Asia lies in moderating inflation. Consumer-price gains have been below economists’ forecasts for at least three straight months in many of the region’s biggest economies, namely China, Indonesia, Taiwan and Thailand.

Bank Indonesia governor Perry Warjiyo said on Nov 17 that core inflation is set to peak early next year. The Bank of Korea on Nov 24 forecast inflation to average 3.6 per cent next year, weaker than it had predicted in August.

Inflation is coming under control in Indonesia and South Korea, “which is our top two local-currency debt calls in EM Asia”, said Jon Harrison, managing director for EM macro strategy at macroeconomic forecasting consultancy TS Lombard in London.

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Peak rates

Anticipation of easing inflation is spurring central banks to signal the tightening cycle is almost over, indicating the peak will be lower in Asia than in the other EM regions.

The policy rate in Thailand is still below pre-pandemic levels, while Malaysia’s is back where it was in March 2020. The benchmarks in those two countries, along with Indonesia and India, are less than 0.9 standard deviation above their five-year average. A similar gauge for Brazil, Mexico and the Czech Republic is above 2, while for Colombia, Hungary and Chile the figure is 3 or higher.

Fund flows

There’s also room for a return of foreign funds after overseas investors cut their bond holdings across the region this year, with China, Indonesia, Malaysia and India all seeing net outflows.

DBS predicts that Indonesia, which is often seen as a bellwether for the region, will attract bond inflows of US$3 billion to US$7 billion in 2023, according to a note published this month. That follows net outflows of US$9.6 billion this year, the most in Bloomberg data going back to 2010.

“Indonesia is attractive thanks to its higher yield, and in a more risk-positive environment, Indonesia’s bonds should benefit from increased portfolio flows,” said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management in Geneva.

China recovery

The final catalyst that may propel Asian bonds is the long-awaited reopening of China, when the nation takes further steps to wind back its zero-Covid restrictions. The authorities have already begun to move in that direction, announcing earlier this month that travellers were required to spend less time in quarantine.

Preparation work has already begun for a meaningful reopening of China so “Asia’s economic cycle remains very much alive”, said Min Lan Tan, head of the chief investment office for Asia-Pacific at UBS Global Wealth Management in Singapore.

An increase in protests against Covid restrictions is adding an extra uncertainty. Demonstrations have taken place across China in recent days as citizens take to the streets and universities, venting their anger and frustrations on local officials and the Communist Party.

Swelling protests against China’s virus-induced curbs may even end up supporting asset prices by encouraging President Xi Jinping to accelerate the nation’s exit from zero-Covid, according to some market watchers. BLOOMBERG