Navigating the Asian fixed income landscape in H2 2024

IN THE first half of 2024, Asian fixed income markets have delivered stellar performance, despite the global economic uncertainty. Asian credit has generated a total return of 2.8 per cent, while Asian high yield has led the way with 10.5 per cent.

Notably, China’s fixed income sector has been a standout, with China investment grade and high yield returning 2.4 per cent and 13.9 per cent, respectively, defying the bearish sentiment that dominated initial forecasts.

Looking ahead to the second half, Asian fixed income is expected to remain on a stable footing, driven by three key themes: a stable political landscape, an improving credit cycle, and “carry-with-risk” discipline.

Political stability with policy continuity in the region

In contrast to heightened politically driven market volatility seen in other regions, Asia has cruised through an election-heavy first half of the year unscathed.

In India, despite the failure of the Bharatiya Janata Party to secure an outright majority, the economic outlook remains robust, driven by structural growth factors. The FY2025 budget unveiled during Narendra Modi’s third term continued to impress with its continuity in fiscal consolidation, laying out its road map for long-term reforms while balancing economic priorities in the near term. We think the government’s plan to lower its debt ratio will be seen favourably by rating agencies.

In China, the recent Third Plenum generated little surprise, reiterating the long-term goal of building a “high-standard socialist market economy” by 2035. The tone of the communique was pragmatic, with the word “reform” repeated 53 times and “development” 44 times.

The plenum was expected to focus on long-term structural reforms and strategies. But discussions touched upon this year’s gross domestic product growth target (5 per cent), property and local government debt, signalling the recognition by the top leaders of the urgent need to address such issues. We await the year-end Central Economic Work Conference and the 2025 National People’s Congress for any legislation to facilitate the reform agenda.

In general, we expect a continuity of policy adjustments since the April politburo meeting, aiming to maintain a baseline of economic growth. The economy will continue to grow below potential because of structural imbalances and continuous drag from the property sector, but we expect incremental procyclical policies in the second half. Overall, we think China government bond yields are entering a consolidation phase after a strong bull run year to date, although we see limits on how much yields can rise.

In Indonesia, president-elect Prabowo Subianto has signalled intentions to increase fiscal spending and relax the debt-to-GDP ceiling. This, coupled with the scheduled departure of respected Finance Minister Sri Mulyani Indrawati in October, raises concerns about a potential deterioration in fiscal discipline. However, improving foreign exchange reserves and a conservative bond issuance plan should support Indonesian government bonds in the near term.

Overall, with the US Federal Reserve in no hurry to lower interest rates, we see “carry” as the main theme for Asian rates and FX strategy in the second half of 2024. We are constructive on higher-yielding bond markets where inflationary pressures are contained, such as Indian and Indonesian government bonds, preferring the five-year tenor due to the flatness of both yield curves.

Improving credit cycle with declining default rates in Asia

Recent earnings reports from Asian corporates and financial institutions have further confirmed that Asian credit is in a sweet spot of the credit cycle. Most corporates have shown resilient fundamentals, evidenced by stable leverage and decent liquidity. Credit ratings have largely remained stable, with downgrades confined to sectors identified as being in a downcycle, such as Chinese non-bank financials and real estate.

Notably, the Asia high yield default rate has significantly decreased to 9.1 per cent in the first half of 2024, from double digits since 2021, according to Bank of America data. We anticipate that the rating trajectory will remain stable, with default rates normalising to mid-single digits.

Carry-with-risk discipline: Key performance driver amid tighter valuations

The broad-based rally in the first half of the year has led to tighter spreads in sectors like Macau gaming, India infrastructure, China tech and South-east Asia Additional Tier-1 bonds.

However, the current yield of JP Morgan Asia Credit Index (JACI) at 6 per cent remains attractive in a historical context, supported by Asia’s stable fundamentals and low historical volatility. This makes carry, which focuses on generating income from holding the bonds, the most attainable investment strategy, particularly given Asia’s stable fundamentals, supportive technicals and low historical volatility.

Despite strong outperformance in the first half, Asia high yield continues to offer attractive opportunities compared to other markets. As of the first half of 2024, JACI BB corporates still offer around 100 basis points (bps) more yield than US BB corporates, while JACI B corporates offers nearly 350 bps to US single-B corporates, according to JP Morgan. While the risk premium is expected to normalise as default rates improve, this process may take longer than six months.

The best carry opportunities are anticipated to come from sectors and companies in the sweet spot of the credit cycle, such as Indian infrastructure, Chinese utilities, Macau gaming and selective financial capital structure securities, where the credit trajectory remains stable to positive, default rates are low and total yield is reasonable.

While mainly pursuing a carry strategy in the second half, we continue to see market dislocation and alpha opportunities in Asia credit, particularly in the high-yield space. Our earlier convictions on a few China real estate survivors, as well as dislocations in China’s industrial sectors, have played out well and will continue to provide superior return potential versus the rest of the market.

All in all, we believe Asia has embarked on a multi-year virtuous circle in the mid-to-long term, driven by stronger economic fundamentals, pro-reform governments, a superior infrastructure ecosystem, favourable demographics and relative political stability.

These factors will enable the region to seize new growth opportunities and attract substantial capital inflows, ultimately leading to reduced FX volatility and a significant revaluation of local bonds and credits.

The writer is chief investment officer for fixed income, Asia-Pacific, Allianz Global Investors