4Q 2019 market outlook in 3 charts
Yield can still be found in a low rate, low inflation and low yield environment.
This has been quite a midsummer’s nightmare for investors, coming off an escalation of US-China trade tensions, a debate over the renminbi, slowing growth in major economies, alongside a frenzy in the bond markets over curve inversions.
Against this backdrop, our Global Fixed Income, Currency & Commodities Team believes this turbulent period could serve as a good environment to engage in active investing within Asian debt markets to find income opportunities and manage risks.
Despite all the negativity, the good news is we’ve already had quite a few rounds of trade tariffs to serve as a guide of what to expect:
Assuming more tariffs to come, economic data is likely to decelerate further but may also prompt increased policy response by Asian central banks to ease and offset growth headwinds. Rate cuts would be positive for local bond duration (i.e. local bonds with longer maturities) but could also be negative for some Asian currencies due to interest rate differentials versus the US.
As such, based on their investment objectives and risk appetite, investors could consider keeping exposure towards longer maturity local government bonds coupled with active management in currency risks1.
Whilst the top-down approach suggests exposure to longer maturity bonds, we believe there are also potential opportunities from bottom-up selection - especially in a backdrop of increasing negative-yielding debt in developed markets.
Asia, in particular, has potential opportunities as some Asian markets have lagged the US Treasuries rally. Meanwhile, most bonds are still positive yielding2.
Year-to-date change in yield-to-maturity of various 10-year government bonds2 (in basis points)
Yield-to-maturity of various 10-year government bonds2 (in %)
The key idea for us, is to find a middle ground between countries that offer potentially attractive bond yield, but also have additional policy headroom for more easing if the economic climate deteriorates further. In our opinion, some opportunities in this backdrop include1:
Although there is a compelling investment case for buying local government bonds, one should not simply gain exposure by passively investing in index names.
As shown below, the returns of local currency government bonds so far this year were diverse and offered opportunities for investors. In particular, some investments would have benefited from tactical foreign exchange hedging and long duration bias, while some others such as the Philippines and Thailand did remarkably well regardless of currency hedges.
2019 Year-to-date Asia local rates and FX total return5
Amid elevated uncertainty and volatility, we believe a more active management style is critical for investors. This is particularly so in strategies with the ability to capture returns resulting from macro themes as we are more likely to have further episodes of start-stop on risk sentiment, followed by roller-coaster thrills in asset pricing for the time being. It is thus imperative for investors to utilise skilled security selection to navigate the markets.
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