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Stars are aligned for Asian bond markets
Publication Date : 31-07-2012
We have seen a significant rally in Asian bond markets in July, with bond fundamentals very positive, supported by strong foreign inflows, dovish central banks and sanguine bond supply conditions.
Bond yields are now very low in developed markets, where front-end yields are negative (or near zero) in several European bond markets, such as Germany, Finland, the Netherlands and Austria.
This negative yield environment is prompting a renewed surge in foreign bond inflows into Asian bond markets. In addition, as we have stated on several occasions, since the start of this year real money accounts have been underweight on Asian bonds versus being selectively overweight on Latin American and Eastern European bond markets.
Investors previously preferred Eastern European bond markets, such as Poland, Hungary, South Africa, Turkey and Russia, because they offered higher yields than Asian bond markets, such as Malaysia and Thailand. Meanwhile they preferred Brazilian bond markets, which have been cutting rates aggressively. This has been the trend from around September 2011 to around June this year.
Feedback from investors in June was that they were overweight on cash going into the Greek election and EU Summit, as a defensive play. However, both events resulted in a risk-on rally, which spurred investors to cover some of their underweight positions in EM (emerging market) assets, particularly Asian bonds. For example, foreigners bought US$592 million worth of Indonesian bonds in the first three weeks of July (compared with cumulative inflows of just $162 million in H1).
Anecdotally, we have also seen inflows to the South Korean, Malaysia and Thai bond markets in July. Going forward, we expect developed market (DM) bond yields to remain low in the coming months, which should sustain the gradual asset allocation shift from DM into EM bond markets in the search for yield.
Besides increased dovishness from major central banks, such as the ECB, BoE and BoJ, Asian central banks have also become more dovish over the past month, with the People's Bank of China (PBoC), Bank of Korea (BoK) and Bangko Sentral ng Pilipinas (BSP) cutting their policy rates. Going forward, we expect the PBoC (-25bps), BoK (-25bps) and Reserve Bank of India (-25bps) to cut rates further this year.
We expect other central banks in Asia, such as the Bank of Thailand, Bank Negara Malaysia and Bank Indonesia to remain on hold this year, although risk is skewed towards them becoming more dovish if the European debt crisis deteriorates in the second half of 2012. Given this relatively dovish backdrop for Asian central banks across the region, local investors are also extending duration and adding bond inventory.
Bond supply conditions in Asia are also very conducive, as governments are generally ahead of the run rate in terms of bond financing. So given the combination of a pick-up in foreign inflows, dovish central banks and sanguine supply conditions, we are generally constructive on Asian bond markets in the coming month.
Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.