(Bloomberg) -- Emerging Asian bonds have bounced back from their Covid-era losses in recent months but they are likely to trail behind their developing-nation peers next year.
Sovereign debt in Asia looks less attractive than its emerging counterparts on a number of metrics that compare the current situation versus a five-year average. These include relatively tight spreads over US Treasuries, smaller real yields, less room for central bank interest-rate cuts, and lower carry return.
A gauge of regional debt has returned about 3% this quarter, based on Bloomberg indexes, amid optimism interest rates are near their peak and China is moving toward an economic reopening. Yet, there is concern the best part of the rally may be over.
“Given the aggressive bond rally in the Asia seen in recent weeks, it’s hard for the market to price in additional supportive factors,” said Philip McNicholas, Asia sovereign strategist at Robeco Group in Singapore.
Here are four charts showing challenges facing emerging Asian bonds:
The spreads on emerging Asian bonds over US Treasuries are almost all below their five-year averages. Malaysian 10-year debt, for instance, offers a premium of only about 60 basis points over similar-maturity US notes, which is 2.2 standard deviations below the five-year mean.
The relatively narrow spread reduces the allure of Malaysian bonds to dollar-based investors, and limits any potential gains. This thin valuation means the nation’s debt is likely to struggle to outperform core markets, Goldman Sachs Group Inc. said in a research note last week.
Emerging Asia bonds also offer smaller real yields than their five-year average, partly due to an upsurge in inflation. Indonesia’s 10-year notes have an inflation-adjusted yield of just 150 basis points after the consumer price index jumped above 5% in each of the past three months. That real yield is more than 3 standard deviations below the five-year mean.
The reopening of China from its Covid lockdowns will be positive for regional economic growth, but potentially negative for the inflation outlook. The potential return of Chinese travelers in the second half of 2023 may spur inflationary pressures in Thailand, Vietnam and Singapore, Citigroup Inc. analysts including Johanna Chua wrote in a research note last week.
Policy makers in many emerging Asian nations have been raising interest rates in recent months to combat inflation. Still, policy rates in most of the region remain relatively low on a historical basis in comparison to global developing-nation peers.
Policymakers in Brazil, Mexico, Colombia and Chile have collectively raised rates by almost 3,800 basis points since last year, while their counterparts in Malaysia, Indonesia, Thailand and Philippines have only hiked by just 650 basis points. That means Asian central banks have less room to make bond-friendly rate cuts next year, if a global recession requires it.
Finally, emerging-Asian currencies offer less attractive carry than their peers in other developing nations as policy rates are lower in the region, both in absolute terms and on a historical basis.
In Thailand, for instance, three-month implied rates for the baht are around minus 0.6%, which makes them about 2 standard deviation below their five-year average after adjusting for US funding costs.
(Updates prices in sixth paragraph)
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