03 April 2020
Global markets have just experienced one of the most volatile periods in history. Asia investment grade bonds were not spared, as credit spreads widened to decade-highs.
Uncertainty remains, but new cases of the Covid-19 outbreak have been declining across much of Asia. China is starting to head back to work and South Korea is also showing positive signs of containing the outbreak. In response, the Asia bond market is also showing signs of stabilising. Liquidity and sentiment are improving; prices may follow.
Previous large sell-off periods in Asian investment grade bonds typically lasted for 3-6 months, followed by a strong recovery with several months of positive returns. While it is difficult to say what shape the rebound from the current crisis will take, as we continue working through the Covid-19 outbreak, and massive coordinated stimulus from governments and central banks take effect, the fundamental drivers to Asia’s investment grade bond market look sound.
It’s worth noting that in this new era of mega size stimulus, Asia is broadly in line, but China has done slightly less than market expectations. We consider this a good sign, as China will be taking a more targeted approach to stimulus, which is better for long-run fiscal positioning. Policymakers remain focused on employment and social stability, as well as on saving some dry powder in case, for example, we see a second wave of infections as the lockdowns are lifted.
Low oil prices are another under-appreciated catalyst for the Asian IG market. As Asia is a net energy importer, this is hugely beneficial; the weaker demand from the Covid-19 drag will offset the benefits in the near term but the cheap oil will give a boost to the region once people start spending again.
Credit selection would be critical to avoid fallen angels, especially when we see further deterioration in Asia macro conditions, management changes in companies or sovereign ratings downgrade. But the risk is manageable, according to our estimates. So far, around 100 issuers in Asia IG are rated BBB-, but we see less than 10 issuers within our coverage facing higher risk of downgrade to high yield.
In the medium term, the supply and demand dynamics to the Asia IG market remain favourable for investors. While net supply is expected to remain benign in 2020, a strong investor base in Asia anchors demand, snapping up nearly 80% of new issues last year. Long term, Asia IG demand is further supported by the aging population and structural current account surpluses in many Asian economies. These trends are unlikely to reverse anytime soon.
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