06 August 2018
Value to be found in Asian bonds
Chinese policymakers have reaffirmed their focus on economic stability with a raft of targeted measures to ease credit conditions away from the property market. This was a significant development given the worrying slowdown in broad credit expansion, which continues to run at the slowest rate since mid-2015.
A confidence-boosting statement from the recent Politburo economic conference, China’s most important mid-year economic meeting, followed hot on the heels of these measures. While much can be read between the lines, our key takeaway was that President Xi Jinping currently prioritizes financial stability over debt deleveraging.
These developments are positive for Asian bonds, which have already begun to rally, especially high yield debt. High yield credit spreads remain a long way off their recent tightest levels and nearly 200 basis points wider than US high yield credit spreads - a level not seen since the devaluation of the renminbi in 2015. Against these attractive valuations, easier credit conditions in China should help issuers continue strengthening their balance sheets.
Source: Fidelity International, Bloomberg, August 2018
China government bonds also offer value and could enter something of a sweet spot if the renminbi begins to stabilize. An average yield of around 3.5 per cent offers a decent income return with some scope for capital gain with slowing domestic growth, contained inflation and more accommodative monetary policy.
However, it’s likely too early to call an end to the depreciation of the renminbi and other Asian currencies, except the Japanese Yen. Developments in the US-China trade war are likely to continue creating uncertainty in the outlook for the renminbi, despite policymakers’ recent effort to make it harder to short the currency.
The US Federal Reserve left policy rates unchanged last week, but the Federal Open Market Committee upgraded its wording related to economic strength in the accompanying statement. A rate hike in September now appears like a done deal, helping to anchor the short end of the US yield curve and support the US dollar.
Japanese financials get a break
The outlook for the yen is more nuanced following the Bank of Japan’s forward guidance and inflation forecast downgrade last week. The central bank faces an impossible task trying to alleviate pressure on the domestic financial system from years of negative interest rates, while maintaining downward pressure on the Yen. It seems they’ve leaned more towards the former in this latest move, which is positive for bank and insurance stocks.
Japanese bond yields fell after the central bank doubled the trading range for the 10-year JGB to 20 basis points, but this is likely a temporary move. There is enough underlying strength in the Japanese economy to suggest the upper limit to the range will be tested at some point and this will be positive for financial institutions earnings while increasing the chance of yen appreciation.
Also, while the decision to reduce the amount of current account balances to which a negative interest rate is applied is likely to only have a small impact, the decision to change the composition of ETF purchases is more meaningful for financial stocks, particularly banks. The purchases will now be skewed heavily to the TOPIX and away from the Nikkei indices, where the financial sector represents a higher share of total market value. Banks have a 7 per cent weight in the TOPIX versus 1 per cent and 6 per cent for the Nikkei 225 and Nikkei 400 respectively.
Source: Fidelity International, Bloomberg, August 2018
Japanese financials continued their rally after the announcement, but offer plenty of scope for further return. Valuations look very attractive on forward price earnings ratio and price -to-book value.
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