Why the Outlook for Asian Bonds Remains Upbeat
Despite concerns about interest-rate pathways and inflation, Asian economies and bond markets look set to perform well in the second half of 2024.
One persistent theme driving Asian bonds throughout the first half of 2024 was the expected trajectory for US interest rates. In the period's early stages, the market anticipated several rate reductions during the year. However, robust US economic data and sticky inflation led the US Federal Reserve (Fed) to delay the start of its rate-cutting cycle.
It's an oft-used term, but ‘higher for longer’ certainly relates to this situation. From an Asian perspective, higher US borrowing costs limit the ability of specific economies across the region to reduce interest rates. Such a move could dent currency values and trigger inflation, thereby reducing these markets’ relative attractiveness to investors.
The European Central Bank1 and the Bank of Canada have already kicked off their rate-cutting cycles. When the Fed eventually starts to reduce its rates, several Asian markets are expected to follow suit. This should boost the attractiveness of the region’s bonds and encourage more significant corporate issuance. It may also help boost economic growth.
The Effects of a Strong US Dollar on the Region
The US dollar has remained firm during 2024 as the American economy has continued to perform strongly, and the aforementioned rate cuts have been delayed.2 While a robust dollar does act as a headwind, the gusts are less of an issue for Asian markets than in previous economic cycles, as government bond issuance is now mainly denominated in local-currency terms, which removes exposure to currency risk. Also, many Asian markets have bolstered their fiscal position, and a growing number of local participants are actively engaging with the fixed-income market. As a result, this has deepened the investor pool and helped reduce the impact of volatility on foreign investment flows.
Attractive Bond Returns in China
From a market perspective, headlines have focused on the challenges faced by China’s real-estate sector and their impact on the broader economy. However, it is worth noting that the central government is trying to manage these risks with supportive policies and programs.3 Despite this uncertain backdrop, the International Monetary Fund (IMF) expects China’s GDP to grow by 5% in 2024 before easing to 4.5% in 2025.4
Indeed, concerns about China’s economic outlook have stimulated demand for what investors view as less risky investments. This has led China’s 10-year government bond yield to reach a near-record low of 2.28% in early July 2024, considerably weaker than the US 10-year Treasury yield of around 4.30%.5
The People’s Bank of China has already announced plans to sell fixed-income instruments borrowed from major institutions to place downward pressure on bond prices and prevent further yield declines.6 The intention is to maintain a normally shaped yield curve, ensure financial stability and provide more market liquidity.
Geopolitical Events Remain in Focus
Looking ahead, we will remain mindful of the potential impact of various global events on Asian bond markets. For instance, the US Presidential election in November could lead to heightened volatility stemming from uncertainty over future policy direction. Also, events in the Middle East have, so far, been relatively contained, but if the conflict escalates, this could disrupt global trade routes.
That said, trade tensions between the US and China could indirectly benefit other Asian markets. For instance, mainland Chinese companies are investing in Malaysia to help hedge against further trade restrictions and continue servicing Western companies. One example is the state of Penang, which reported foreign direct investment of US$12.8 billion in 2023, more than the combined total it received from 2013 through 2020.7
Positively Interlinked with the Global Economy
If the global economy achieves a soft landing and inflation moderates, the outlook for most Asian markets should be upbeat. The region’s economies, while diverse, are positively interlinked with the rest of the world through trade and foreign investment. This economic dynamism is evident with the IMF, in its April World Economic Outlook, projecting a robust GDP growth rate of 5.2% in 2024 for emerging and developing Asia.8 Risks remain on the horizon, but there are still plenty of interesting opportunities spanning various sectors and markets to attract local-currency bond investors.