Asian Fixed Income Commentary – Post-Fed Rate Hike
With US employment data looking bright and inflation pressures more likely ahead, the market is pricing in more US Federal Reserve (US Fed) rate hikes in 2017. Given this, we favour a shorter-duration, US dollar bias strategy in the near-term. As it is expected that there will be additional rate hikes in 2017, the dynamic approach to duration management adopted by our strategies will continue to provide mitigation to downside volatility. Ahead of the Federal Open Market Committee (FOMC), our portfolios were positioned with duration hedges and benefited when US Treasury 10-year yield moved from 2.42% to 2.58%. We recently took profit on this trade. We will continue to manage the duration of the portfolios tactically.
Looking into 2017, the key focus early in the year will be Donald Trump’s inauguration and his policy agenda. If not executed properly, we believe an expansionary fiscal policy combined with protectionist policies could lead to much higher inflation. The US economy remains highly leveraged and the threat of much higher interest rates could put a brake on growth. Political events in Europe will also be key to watch next year as will be China risks, geopolitical risks and the direction of oil prices. In Asia, we watch closely for reverberations from any trade protectionist policies from the Trump administration. Inflation remains benign so we expect monetary policies to overall remain accommodative although further monetary easing is less likely. Public infrastructure spending is ramping up in 2017 with China, India, Indonesia, Thailand and the Philippines all flagging large projects where in many cases, fiscal resources are already secured. Areas of focus include roads, bridges, railways and ports.
Asian Fixed Income Strategy
Foreign exchange strategy: While the near-term is less favourable for Asian currencies, the US dollar is at a 14-year high and we expect to see a period of consolidation at some point which will provide tactical opportunities, particularly for countries with stronger current account surplus such as Singapore dollar (SGD) and Korean won (KRW). The stronger fundamental backdrop of Indonesia also makes the Indonesian rupiah (IDR) an attractive candidate and we watch for opportunities to add exposure. India, with a more domestically focused economy and low foreign ownership of its local currency bonds, should shield the Indian rupee against a sharp depreciation.
Rates strategy: Shifting global monetary policies (including US Fed hikes and European Central Bank (ECB)/Bank of Japan tapering concerns) and reflation expectations will likely drive steeper yield curves. We expect most Asian economies to decouple from the US and maintain relatively accommodative monetary policy stances although further monetary policy easing from here is less likely. This means we expect Asia’s front-end to be capped but we could see steeper curves in some countries. We continue to like the shorter-end of India and Indonesia given relatively high absolute yields and flat yield curves.
Credit strategy: We believe Asian credits can continue to generate positive returns in 2017 (albeit lower than in 2016) driven by yield pick-up and security selection. Asia remains more resilient within the emerging markets universe given better fundamentals and stronger local investor support. The default forecast for Asian High Yield credit remains at relatively low/moderate levels of 2-3% for next year. In a rising interest rate environment for US Treasuries, an active approach to duration management is imperative and we will continue to actively manage interest rate risks for our portfolios.