Asia Fixed Income Investment Outlook – Quarterly Update

Author: Chris Lau, Senior Portfolio Manager, Invesco Fixed Income

Global macro events continued to dominate the market in recent months. Both the surprise 50 bps cut by the US Federal Reserve (Fed) at the September Federal Open Market Committee (FOMC) and China’s easing announcement have been constructive for Asian credit. Nonetheless, the repricing of the Fed policy path and the US election have greatly increased uncertainty and volatility. Despite the massive sell-off in US rates, Asia investment grade (IG) still recorded a decent return year-to-date as spreads traded at historical tights.  

Recently strong US macro data has reset a less dovish path for expected Fed policy. The president-elect Trump’s victory and a likely Republican sweep is expected to push US rates higher as all of his major policy initiatives (tariffs, fiscal policy, immigration) are inflationary and the fiscal deficit is set to materially widen. At the latest November FOMC, Fed Chair Powell declined to comment on Trump’s policy agenda and the appropriate Fed response. He reiterated that the Fed’s policy decisions would be data dependent, and the current economy still supports further easing as the labor market and wages have cooled and inflation has been trending toward the Fed’s target.

The market has significantly pared down rate cut expectations since Trump won the presidential election. Beyond January, heightened policy uncertainty may lead the Fed to move more slowly than it otherwise would. The Fed Fund futures market is now implying less than 100bps of cumulative easing through 2025. Asia IG spreads continued to tighten in Q4 despite the sell-off in US rates. JP Morgan Asia Credit Index (JACI) IG spreads have tightened -27bps to 70 basis points (as of Nov 8, 2024) from +97bps (as of Aug 16, 2024). Nonetheless, Asia credit investors are comfortably holding onto bonds despite rich valuations and escalated rates volatility. With stable fundamentals and low default rates, Asia credits appear attractive from all-in yield perspective. 

Emerging market (EM) Asia economic growth has been growing at a healthy pace. While exports may remain resilient in the next 1 or 2 quarters on front-loaded shipments, keeping real GDP strong, US tariffs will likely be the key downside risk to growth in 2025. A strong US dollar could pose headwinds and limit the potential room for EM Asia to lower rates even though core inflation is trending down. Despite the potential challenges to the overall EM Asia economies, we believe Asia IG corporates’ credit fundamentals may remain largely stable with ongoing deleveraging and sufficient liquidity.  

Market technicals continued to be supportive even with a pickup in new supply year-to-date. Negative net supply is likely to remain due to bond redemption and coupons. We expect the primary market to become more active if US rates trend lower later next year. In general, the primary market does present some attractive relative value opportunities. We expect new issue supply to remain strong in 2025 led by financials, whereas sovereign new issuance will continue to lag. We believe the primary market will likely continue to be a focus for investors, and new issue performance and technicals are likely to drive market performance.

Asia IG credit spreads are currently tight relative to historical standards as well as compared to global IG peers. Asian financials, bank tier 2 papers and insurance company subordinated debt are the key areas that look compelling in terms of relative value. We started to see a risk premium at the longer-end of the credit curve post the recent rates sell-off. However, we continue to prefer 5-7years over the longer-end given the potential rates volatility. Despite trade tariff threats, we remain constructive on China IG in the medium term and expect companies to benefit from China’s easing policy and stimulus. In addition, we think China IG credits should continue to enjoy strong technicals driven by onshore buying interests. We expect Asian IG credit spreads to broadly remain range-bound for 1H 2025 despite near-term volatility. Asia IG yield offers at 5 to 5.20% low volatility returns appear very attractive. All-in yield buying interests should continue to drive investor flows.

President-elect Trump’s policy will likely set the tone for all asset classes in 2025. However, Asian central banks are expected to respond with policies that will support exports and domestic demand. In the medium term, we believe US inflation will consolidate around current levels. Growth however should continue to slow and justify the Fed’s easing cycle. We believe Asia IG credit will continue to deliver solid returns in 2025, mainly supported by the moves in US treasuries. Despite the uncertainties in US policy and the rates path, stable fundamentals and strong technicals in Asian credits should keep spreads tight. Receding rates volatility in 1H 2025 should gradually attract fund flows into Asia IG. While we do not see scope for material spread compression in Asia IG from current levels, we believe the high all-in yields should continue to be supportive for 2025.

Author: Norbert Ling, Portfolio Manager, Sustainable and Impact Investing, Invesco Fixed Income

In 2024, the JP Morgan Asia Credit Non-Investment Grade Index continued to build on its positive total return with the index up by 16.1% year-to-date (as of November 8), outperforming both US and European high yield (HY) indexes.¹ The high total return has been driven by spread tightening across various sectors aside from just the real estate sector, as evidenced in Table 1.

The relatively benign Asia HY default rate of 4.2% year-to-date (as of 23 October), the lowest since 2020, has also proved to be supportive of total returns in the asset class.²  Within the 4.2% default rate, we have observed that most defaults occurred in the real estate sector. Outside of this there has been only one issuer that has defaulted thus far this year. This occurrence was classified as a default due to a distressed exchange rather than because of a missing coupon payment, principal repayment, or restructuring. 

Heading into 2025, we highlight the following topics that may be of interest to investors looking at the asset class.

Dissecting the Asia HY asset class

Asia high yield is a short duration asset class at just 2.4 years (as of 8 November) with lower rate sensitivity as compared to Asia investment grade (IG). Given the backdrop of limited high yield issuance and the real estate sector shrinking in weight, the market value of the JP Morgan Asia Credit Non-Investment Grade Index declined from US $235 billion at the end of 2021 to $138 billion at the end of October 2024.³

BB-rated bonds have consistently remained the largest component of the index over the last few years at around 45% weighting (Figure 2). On the other hand, we have seen a ratings migration from single B into the CCC category since late 2021. In our Asia Q4 HY outlook, we also noted the increasing weight of India within the Asia HY asset class as a positive dynamic.

We continue to favor BB-rated issuers which have robust credit fundamentals and consistent cash generation through the credit cycle to pay down their debt. There are also potential rising angels that could get upgraded to IG in the next 12 to 18 months. We remain selective within the single B space and are paying particular attention to their refinancing plans while also leveraging our credit research expertise to engage continuously with the companies on their short-term operating trends.

From a sector perspective, we continue to favor Macau gaming, renewables, subordinated financials, infrastructure and consumer companies. This shows the value of diversification within this asset class to obtain multi-sector exposure to fast-growing economies in Asia. We think that it is important to have the flexibility to invest across BB and BBB-rated names as we can harvest credit premium and a broader spectrum of opportunities by investing in names in these rating categories.

How do Asia HY market valuations compare to global HY markets?

In our Asia HY Q4 outlook, we argued that Asia HY markets offer attractive valuations versus US HY with a yield pick-up opportunity. With the recent rally in Asia credit spreads, we have seen that Asia (ex-real estate) BB names have compressed to almost flat to US BBs (Figure 3). The valuation opportunity where Asia HY remains cheap relative to global HY is largely within the single B space. We would highlight Mongolia, commodity names, and double-digit coupon bonds in performing credits as investment opportunities that could provide both income and capital appreciation potential.

Reviewing capital structure for investment opportunities within Asia HY

There has been an increase in asset-backed securities issuance and convertible bond issuance by Asia HY bond issuers in recent years. We see this as a positive development as it provides investors with the opportunity to generate more alpha by selecting the part of the capital structure that has the highest risk-reward profile. This is where we think active investing will be a key differentiator, as both asset-backed securities (ABS) and convertible bonds are not part of the JP Morgan Asia Credit Non-Investment Grade Index, but they leverage on the same fundamental credit view of the issuer.

For instance, we see opportunities for portfolio upgrading by switching from a vanilla HY-rated corporate bond into an IG-rated ABS bond of the same issuer, which has the benefit of a social use of proceeds. Similarly, given the strong spread rally within the asset class, we also favour opportunities to switch into convertible bonds where the downside is limited to the bond floor. In these examples, we look for bond issuers with a high free cash flow to equity, where deleveraging is accretive to equity value and will increase the value of the embedded equity call. This also serves as a good hedge versus more equity friendly behaviour by issuers, with the alignment of interest of a convertible bond holder more akin to equity but with a bond floor.

Author: Yifei Ding, Senior Portfolio Manager, Invesco Fixed Income

We have had major shifts in the US recently as the US Federal Reserve started cutting rates in September 2024 and the presidential election was held in early November. We are set to have the second Trump administration with an easing bias in terms of monetary policy going into 2025. Some of the policies Trump proposed during his campaign look negative for emerging markets, particularly export-oriented emerging market countries. While we wait for the details to pan out in the coming months, we take comfort in the fact that Asia emerging market (EM) countries continue to have robust economic fundamentals compared to the rest of the world. 

As growth slows down globally, healthy growth and robust government balance sheets among Asian emerging market economies may provide better downside protection for asset performance in the coming quarters. We are also encouraged by recent policy shifts in China as the government has started to emphasize the growth target more frequently. At the same time, the market is still waiting for more details and the impact of China’s recent stimulus package as well as clarity on potential headwinds coming from US policies. We believe that if US policies against China and other emerging markets became more aggressive, the Chinese government may potentially push through more measures to support domestic growth. If this occurs, our base case is that these two sets of policies are likely going to offset each other in terms of the overall impact on Asian EM countries’ fundamentals.

Although we think robust fundamentals could provide better protection for Asian EM sovereign and quasi-sovereign bonds in a sell-off environment, we still feel the valuations of these bonds are currently trading at very expensive levels, particularly investment grade (IG) bonds. In earlier years we observed Asian IG bonds trading at much higher yield levels compared to similarly rated US investment grade bonds (Figure 2). However, the yield pickup has since shrunk from approximately 80 to around 30 basis points. 

Given these unfavourable valuations it is difficult to be bullish towards hard currency Asia EM sovereign bonds. The overall US treasury yield curve is likely to move tighter as the US Federal Reserve begins its easing cycle. The potential spread widening may put tight Asia sovereign bonds at risk. Our base case is that Asia hard currency sovereign and quasi-sovereign bond spreads may widen in the coming quarters and likely underperform other emerging market regions due to lower carry and expensive valuations. We are however still positive on Asia EM local currency bonds accounting for our outlook for bond prices and exchange rates in these markets.

With the US Federal Reserve entering a rate cutting cycle in September 2024, Asian central banks now have more room to ease as capital outflow pressures subside. Current real rates in Asia have been hovering above historical average levels. As global economic growth momentum slows, we expect local central banks to become more accommodative by cutting domestic policy rates. This is likely to lead to upside opportunities in bond prices for investing into local currency government bonds. 

We expect Asian EM local exchange rates against the US dollar to generally have balanced risk profiles in 2025. On the one hand, as the US Federal Reserve cuts interest rates more aggressively than Asian central banks, interest rate differentials will work in favour of local currencies. At the same time, the US president-elect Donald Trump’s planned trade policies would hamper local currency performance for economies that are more export driven. We believe Trump’s election is likely to cause more volatility in Asian exchange rates. However, we do not think this cause a persistent depreciation trend of Asian currencies against the US dollar, as the market will mainly focus on fundamental factors such as rate differentials and economic performance.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.