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As U.S. Federal Reserve surprisingly delayed the reduction of its bond purchases in September, most Asian bonds have enjoyed good recovery to date, but analysts cautioned investors against buying fixed incomes of the region indiscriminately.
The minutes released after the latest Federal Reserve's policy meeting dated Oct. 29 and 30 revealed the U.S. central bank was keen to signal its data dependence, and sought more evidence of sustained growth before changing its extraordinary monetary stimulus.
With the tapering of quantitative easing on hold in the United States, funds started flowing back into Asian bond markets. But the threat of bond redemption is likely to return next year when the Federal Reserve starts the process of tapering.
Standard Chartered Global Research forecast the United States to start tapering its quantitative easing program in March 2014, but pointed out the risk is skewed towards further delays, especially if the data do not improve. Delayed tapering implies an extended period of monetary accommodation, which should support fixed income markets.
Standard Chartered believed bond markets will perform well if U. S. Treasury yields stay on a lower trajectory than market expectations a few months ago. It said among Asian bonds, high- grade bonds with AA and A ratings appear attractive versus both their U.S. peers and their estimated fair value from a valuation perspective. Chinese and South Korean corporate bonds dominate the AA and A rated space in the Asian high-grade sector.
But it is the Asian high-yield bonds with the BB and B ratings that "stand out as being particularly cheap to both its estimated fair value and its U.S. peers," said Standard Chartered. With U.S. Treasury yields expected to be on a rising trend in 2014, high- yield bonds in Asia excluding Japan -- when selected carefully -- should likely to outperform the rest of the bond space in the region from a total-return perspective.
As for Asian sovereign bonds, the research house maintained an "Underweight" stance due to their high correlation with U.S. Treasuries which are poised to fall when yields rise as forecast.
HSBC Global Research said while the timing of U.S. Federal Reserve's tapering is an important factor in the performance of Asian bonds, a large proportion of total bond returns in the region and flows can be explained by local exchange rates rather than the absolute level of yields which are correlated with the U. S. Treasury yields.
HSBC pointed out that government bonds of countries liked India with weak currency, high fiscal deficits and low foreign exchange reserves adequacy ratios will be most at risk in the case of outflows. In contrast, government bonds of nations with stable currencies and better macro dynamics such as Singapore and South Korea are expected to prove more resilient.
This is exemplified by this summer when the ticking of the timing of U.S. Federal Reserve's tapering clock grew louder, India witnessed between May and September outflows of almost 70 percent of the capital inflows received during previous quantitative easing by the United States. In contrast, there were hardly any outflows from South Korean bonds. Indeed, foreign investors bought the equivalent of over 1 billion U.S. dollars of South Korean local government bonds in June when the broader sell-off in emerging market bonds was at its peak.
HSBC's study also showed that bond yields in Malaysia, Singapore and Indonesia exhibit the strongest relationships with currency movements, suggesting that investors should take currency volatility into account when investing in Asian fixed income.
