Never mind the trade war. A looming U.S. interest rate cut is set to replace tariff headlines as the key driver of developing Asian bonds, according to money managers.
As traders count down to the Group of 20 summit this week, global funds are looking beyond the outcome to focus on an expected easing in Federal Reserve policy. Portfolio managers reason that regional central banks are likely to follow in the Fed's footsteps, and this would galvanize demand for Asian bonds.
"The good news is the high yielders — Philippines, India, Indonesia — have central banks that hiked significantly over the last 18 months as the Fed was tightening policy," said Mark Baker, investment manager of emerging-market debt at Aberdeen Standard Investments Ltd. in Hong Kong. "It's natural to look to these markets as the first places to reverse some of that tightening."
After a year dominated by haven bids, risk assets are poised to get a new lease of life, thanks to the Fed's recognition that rates may need to fall to prop up growth. Regional securities such as Indonesian and Indian debt, which offer yields that are more than three times those of Treasuries, are a standout in a global environment where $13 trillion of bonds have negative yields.
Rupiah sovereign bonds, which have reeled in more than $6 billion of inflows this year, are a top pick among global funds after Bank Indonesia signaled last week it's ready to cut interest rates in coming months. The debt counts J.P. Morgan Asset Management, Aberdeen Standard Investments and Salter Brothers Asset Management Pty. among its fans.
Yields on 10-year rupiah bonds are the highest among developing Asia's major debt markets, even after dropping to an almost one-year low of 7.39% last week. Bank Indonesia will lower its benchmark rate by a quarter percentage point to 5.75% by year-end, after delivering six hikes in 2018, according to the median forecast of analysts in a Bloomberg survey.
Finance Minister Sri Mulyani Indrawati said Tuesday the central bank "will find the right timing" to adjust policy amid low and stable inflation, with ample room to maneuver in the second half of the year. Nomura Holdings Inc. predicts Bank Indonesia will deliver a 25-basis point cut at its next review, with further easing in the pipeline.
"Our top pick for local interest rates in Asia continues to be Indonesia where we see scope for the central bank to ease policy by more than expected," said Abbas Ameli-Renani, a portfolio manager for emerging markets bonds and currencies at Amundi Asset Management in London. The easier monetary policy adopted by major central banks will "encourage further inflows into EM debt as investors increasingly view EM as the oasis in a yield desert," he said.
Still, Amundi cautions that how the U.S.-China trade row develops will be crucial for the outlook of emerging currencies, with gains likely to be cut short if an agreement proves elusive in the short term.
Similarly, PineBridge Investments warns that Asian currencies may face increased volatility, due to expected swings in the Chinese yuan, and this could pose a risk to the region's bonds.
"Selective Asia central banks may need to cut rates to help support the economic growth," said Arthur Lau, PineBridge's head of Asia ex-Japan fixed income. "This may also add pressure to the respective currencies."
Bonds from Australia to India have risen as central banks turn dovish
Indian bonds are also drawing interest amid speculation the central bank may deliver a fourth rate cut this year, after it recently shifted to an accommodative policy stance. Ten-year rupee yields dropped to 6.73% last week, the lowest since 2017, as overseas investors snapped up more than $1 billion of the nation's debt this month.
Rupee bonds are attractive as the nation is "not a major actor" in the trade war, said Aberdeen Standard's Mr. Baker, adding that the money manager trimmed some of its exposure to Philippine government debt in favor of Indonesia and India.
With Fed fund futures pricing in a 100% chance of a U.S. rate cut next month and the European Central Bank signaling it may unleash more stimulus, global funds are lining up their bets on emerging Asian bonds.
"It's all about going risk-on in the short term at least," said George Boubouras, director at Salter Brothers Asset Management in Melbourne. "It doesn't really matter in the short term that the trade war's going on. As the Fed cuts, that's just going to buoy risk assets -- investors will need to take advantage of that while they can."
It is a view echoed by J.P. Morgan Asset, which expects Southeast Asian economies to successfully navigate the risks stemming from the trade war. And if the effects of a China slowdown spill over to the region, central banks will be "more prone" to cutting rates which will buoy bond prices, said Tai Hui, chief market strategist at J.P. Morgan Asset in Hong Kong.