For the third straight month, July saw good overseas demand for Asian bonds. According to Reuters, a net US$7.91 billion worth of Asian bonds were snapped up during the month. This followed the US$3.03 billion net demand in June, and US$9.50 billion in May. Of particular interest were bonds from Indonesia, India, Malaysia, South Korea and Thailand. The demand for Asian bonds is spurred by a combination of both push and pull factors.

Three key considerations are causing investors to diversify away from US bonds:

It has become increasingly probable that the US Fed will start to cut its rates in September. The only thing that seems unclear at this point is whether the cut will be 25 basis points or a deeper 50 basis points. The latest US CPI report released last week indicate that headline inflation, at 2.9 percent YoY, is running slightly below expectations while the 3.2 percent core CPI is in line with expectations. The stickiness of shelter costs point to a more conservative approach.

On the other hand, the US Fed is also closely monitoring growth indicators such as employment rates and manufacturing growth. Both these numbers have weakened in recent weeks, prompting calls for a bolder rate cut. Whatever the case, a lower policy rate also means a lower bond yield and a weaker US dollar, prompting investors around the world to look for alternative places to park their money.

As if the US elections were not exciting enough, polls now suggest almost even chances of a Harris or Trump win. Economists generally expect a Trump presidency to result in higher Treasury yields given the potential widening of the US budget deficit and release of more US long term bonds. However, in the immediate term, investors are concerned that election uncertainties will be enough to destabilise the market.

There are also good reasons for foreign investors to gravitate towards Asian bonds:

Asia is expected to grow strongly over the next few years, driven by the region’s export recovery. Despite its problems, China’s GDP growth is still expected to be double that of the US, but China is no longer Asia’s primary powerhouse. China’s GDP growth is expected to be overtaken by ASEAN countries over the next few years.

Fig 1: Real GDP growth consensus estimates (%)

^{Source: Bloomberg/UOBAM}

Cheap onshore funding rates and Covid recovery initiatives have enabled the Asian domestic (i.e. local currency) bond market to flourish. As a result, the domestic market has grown substantially over the past five years. In absolute terms, China continues to dominate the market. However, if we assess bond markets as a percentage of GDP, other countries including Korea, Singapore, Malaysia and Hong Kong stand out.

Fig 2: Asia ex Japan credit market size credit market size, US$ trillions

Source: BofA Global Research, Aug 2024

It is also noteworthy that in the first half of 2024, G3 (i.e. USD, EUR and JPY-denominated) bond issuances came back into fashion. Worth US$122.9 billion, this was an 18 percent gain over the previous year, of which about a quarter were from Chinese corporates, and another quarter from Korean corporates, according to data provider LSEG. Meanwhile Indian corporates dominated in the G3 high yield space.

There are also recent developments favouring specific Asian markets and sectors. For example, having rallied by more than 10 percent so far this year, Asian corporate high yield bond returns are well in excess of the global high yields sector. Investors have been taking advantage of the region’s fall in default rates and good company fundamentals, and are likely to continue to do for the rest of the year.

China’s CNY-denominated bond market is also seeing interest return, aside from its property sector bonds. The CNY appears to have bottomed against the USD, but more importantly, China’s domestic bond market is deemed too big to ignore and offers solid diversification benefits given the low correlation to US and other global bond markets.

Gains could slow down but yields remain a draw

So far this year, the interest in Asian bonds has caused sovereign bond prices to rally and Asian credit spreads to tighten. This run up means Asian bonds are not as cheap as they were and gains could start to slow down, especially within the Asian investment grade sector. That said, Asian sovereign bonds are still expected to appeal to foreign investors looking to lock in higher yields. The negative net supply expected for this year should also help support Asia credit markets.