The rebound after the storm
Asian fixed income and its global peers faced a storm of unprecedented challenges in 2022, which led to a total reset for bond markets. Surging inflation amid higher energy prices, rising global interest rates, and escalating geopolitical risks all contributed to a difficult global macro landscape. Meanwhile, idiosyncratic credit risks in the region spiked amid further ructions in Mainland China’s beleaguered property sector. Challenges inevitably persist as we move into 2023, but our experts believe the risk-to-reward opportunities in the asset class for total return are improving amid a higher yield environment and an attractive spread premium. With potentially greater clarity in the movement of rates and currency, credit should lead on stronger government policy, resilient economic buoyancy, and an evolving Asian credit landscape.
After a volatile 2020 and 2021, investors started 2022 cautiously optimistic about a more predictable market environment; however, these hopes were quickly dashed when Russia invaded Ukraine in February, which roiled global markets and amplified underlying inflationary pressures—particularly for commodities.
As oil prices surged and monthly inflation exceeded 8% in the United States—levels not witnessed since the early 1980s—the U.S. Federal Reserve (Fed) embarked on arguably one of its steepest monetary tightening campaigns in the post-World War II period. The federal funds rate jumped from 0.00% to 0.25% (early March) to 4.25% to 4.50% (December), while U.S. Treasury rates surged from 1.51% at the start of 2022 to above 4.20% in November 2022.
Other major central banks (except Japan) and emerging-market central banks quickly followed suit by steadily hiking rates. Mainland China emerged as an outlier, as the country pursued a more countercyclical path to navigate the dual challenges of implementing zero-COVID restrictions and a deteriorating property sector.
2022: a challenging year for global fixed income
This unique macroeconomic landscape presented exceptional challenges for fixed-income investors. The Bloomberg Global Aggregate Bond Index fell by 16.25% in 2022, while the J.P. Morgan Emerging Market Index moved lower by roughly 17.70%.¹ Despite the relatively short duration profile of Asian fixed income compared to global fixed-income markets, Mainland China’s ongoing slump negatively affected Asian fixed-income markets for most of 2022 until the government significantly eased the country’s zero-COVID policies and provided robust stimulus for real estate in November and December.
Asian investment-grade credit demonstrated relative resilience, widening only 25 basis points (bps) in 2022, mainly due to the region’s economic buoyancy and a large proportion of state-owned firms in the credit universe.² Total return contracted by roughly 10.0%,³ largely driven by movements in U.S. Treasury yields. On the other hand, Asian high-yield fell significantly—by roughly 15.1%—for the year, largely driven by wider credit spreads and the uncertainty surrounding the future of the country’s property sector.⁴
Market review of Asian local currency bonds, U,S. dollar credits, and currencies
Source: Bloomberg. J.P. Morgan Asia Credit Index. Index performance data shown in U.S. dollars, as of December 30, 2022. The Asian Investment Grade Corporate Bond Index refers to the J.P. Morgan Asia Credit Investment Grade Corporate Index, which tracks the total return performance of the investment-grade Asia dollar bond market. The Asian Non-Investment Grade Corporate Bond Index refers to the J.P. Morgan Asia Credit Non-Investment Grade Corporate Index, which tracks the total return performance of the non-investment-grade Asia dollar bond market. Past performance is not indicative of future results.
2023: risk/return opportunities becoming more appealing
As we move into 2023, the global macro environment should, at the very least, be more predictable and potentially more accommodating. Indeed, while we certainly don’t envisage a rainbow after the storm of challenges experienced in 2022, we do believe that the asset class will face fewer headwinds, or could potentially experience tailwinds in 2023. Overall, this can lead to more favorable risk/return opportunities and presents potential for a rebound after a year of total reset.
Our base case is that the Fed should move away from jumbo rate hikes (e.g., 75bps), as illustrated in its December meeting and, as disinflationary pressures gradually build, eventually pause. That said, due to elevated inflationary pressures, we don’t view a pivot to interest-rate cuts as a high-probability event.
We believe Asia should be a primary beneficiary of this stabilizing macro environment as the continent’s growth profile remains resilient; however, the region could advance at different speeds. Mainland China’s faster-than-expected relaxation of zero-COVID policies and border opening should ultimately be a key driver for growth in 2023 although there are likely to be challenges along the way. Asia economies outside of Mainland China are also expected to benefit from this positive spillover through increased trade and tourism, depending on their economic ties with the country. Overall, we believe this dynamic should contribute to investment grade’s continued performance and set the scene for a potential rebound in high yield with narrowing credit spreads.
In the next section, we break down our 2023 Asian fixed-income outlook into three areas: credit, rates, and currency.
Foreword: Mainland China’s property sector
After a difficult 2022, we believe Asian credit is poised to be the main contributor to fixed-income returns in the new year.
The Chinese property sector has been a laggard in credit after the government assumed a new (unofficial) regulatory stance in August 2020 (the introduction of the three lines concept). The government introduced policies that aimed to reduce leverage among some developers and the sector’s outsized contribution to GDP (previously 20% to 30% of GDP according to some estimates).
However, these policies contributed to a negative feedback loop: Industrywide deleveraging led to construction pauses on existing projects and some developers put new developments on hold. This heightened uncertainty among consumers about the sector’s prospect, many of whom then chose to sit on the sidelines, is a development that further reduced cash flow available to developers as sales of new properties stalled and housing prices fell further.
Zero-COVID policies arguably exacerbated the fall, as sporadic citywide lockdowns prevented primary and secondary transactions, and home buyers’ demand plummeted.
As a result, the sector had a challenging year: Numerous property developers were downgraded and some defaulted on their debt; others initiated bond swaps while several upstream supply sectors faced bankruptcy. Without significant policy stimulus, many property credits traded at distressed levels for much of the year.
We believe that the government’s most recent policies released in late November have effectively put a floor under the market and bolstered investor confidence. While the sector's recovery should extend over the next two to three years, it should ultimately emerge healthier post consolidation with issuers that have sustainable debt levels and are able to operate with greater economic efficiency.
Perhaps more importantly, we’ve also witnessed a significant change in the Asian credit universe over the past two years. While Chinese real estate composed around 39% of the J.P. Morgan’s Asia Credit Non-Investment Grade index in December 2020, it’s contracted to roughly 13% due to defaults and index removals.⁵ This has resulted in a less concentrated and more diverse credit universe in Asia that offers new opportunities to active managers.
Credit: less concentrated and more diverse
Based on these new opportunities, our proprietary research leads us to be constructive on a few sectors in addition to the Chinese property in the new year: Macao-based casinos, the industrial space in Mainland China, and India’s renewable sector.
- We’re constructive on selective segments of the property sector in Mainland China. We believe November 2022 marked an inflection point in terms of policy measures. These measures, known as the three arrows, ⁶ are viewed by the market as the most comprehensive and coordinated policy response since the start of this crisis. We’ll continue to closely monitor primary market sales transactions, which we believe are vital to a sustainable recovery in the sector.
- The industrial sector in Mainland China has been beaten down amid negative sentiment toward the country’s property sector and concerns about slower economic growth. Yet, the sector benefits from an outsized connection to state-owned enterprises and government support. Given current valuations, a marginal improvement in economic growth from the reopening, and related knock-on effects, the situation should result in better performance and tightening spreads.
- Casinos in Macao have experienced difficult times over the past two years due to reduced tourist flow and lower revenue amid stringent COVID-19 curbs. As a result, valuations are at an attractive level relative to the historical average. We believe the sector could benefit from the reopening of borders in early 2023. Given that the electronic visa system for mainland visitors has been relaunched in early November, we believe tourism and improved business fundamentals should ultimately rebound from the current trough.
- India’s renewable energy sector is expanding quickly as a result of increased investment. The country has made no secret of its ambitious national goals to reach 175 gigawatts (GW) of renewable capacity by the end of 2022 and 450 GW by 2030 as part of the broader push to achieve net zero status by 2070. Investment levels have risen accordingly, reaching a record of US$14.5 billion in 2020/2021, up 175% from the previous year. In our view, high-yield credits within this space could also allow for portfolio diversification, given they’re not correlated to economic activity in any specific commodity.
Rates: increased headroom for monetary policy among Asian economies
In comparison to 2022, there should be greater clarity regarding the trajectory of rates in the new year as the Fed’s monetary policy direction has been relatively better communicated with less uncertainty.
This trend should benefit Asian markets that have experienced a wide dispersion in monetary policy across the region. Indeed, while the central banks in the Philippines and India raised rates by 350bps and 225bps, respectively (both since May), others, such as the Bank of Thailand, have only hiked by 75bps since August. A less restrictive global monetary environment should give more room—from a monetary policy perspective—for Asian countries to promote economic growth and account for differing inflation levels without hiking to keep up with the Fed.
In 2023, we’re particularly constructive on two markets: India and Indonesia.
The country experienced a challenging 2022. While economic growth rebounded strongly from 2021 due to government stimulus and low base effects, rising inflation led the Reserve Bank of India (RBI) to pursue rate hikes aggressively. Accordingly, yields for the 10-year Indian government bond rose from 6.4% in January to around 7.3% in November, its most significant year-to-date increase since 2017. In addition, J.P. Morgan deferred India’s inclusion in its Emerging Market Sovereign Bond Index in November 2022 (the country was placed on positive watch), which led to foreign selling and reduced capital inflows.
Moving forward, we believe that the RBI has largely contained inflationary pressures, which should allow for a pause in rate hikes and a greater focus on driving economic growth in 2023. With further taxation reforms for foreign bond investors, the inclusion of the country’s sovereign debt in global indexes could be possible in the new year, potentially providing an extra boost for investors.
Indonesia experienced a volatile but resilient 2022. Bank Indonesia continued its burden-sharing program with the Ministry of Finance to purchase government debt, which helped to contain rates throughout 2022. As detailed previously, foreign ownership of local currency bonds in Indonesia has steadily declined over the past two years—from nearly 40% at the end of 2019 to roughly 15% at the end of August 2022.⁷
This has led to a more diverse group of domestic stakeholders holding government debt for the long term, specifically local commercial banks and pension funds. Crucially, this shift in ownership pattern has dampened the previous negative dynamic of foreign bondholders selling during bouts of heightened global volatility, which has the effect of driving local yields higher and weakening the Indonesian rupiah.
Foreign ownership of Indonesia’s local currency bonds has declined
Source: Bloomberg, as of December 30, 2022.
At the same time, the country benefited from robust global demand for commodities, as its current account remained in surplus (1.3% of GDP in the third quarter) for the year. Consequently, the rupiah has posted better historical performance during prolonged volatility.
In 2023, we believe the country should have greater policy flexibility: Given the central bank’s current strategy of front-loading interest-rate hikes and providing targeted energy subsidies in the new year, inflation pressures are expected to fall. At the same time, the rupiah should face a more favorable macro backdrop and continued stability through the country’s current account surplus and easing U.S. dollar strength.
Currency: easing U.S. dollar strength
The U.S. dollar outperformed in 2022 on the back of higher rates and surging Treasury yields. The U.S. Dollar Index, a measure of the greenback’s strength against major currencies, moved higher by roughly 8.2% in 2022, while the J.P. Morgan Asia Dollar Index, a proxy for Asian currency strength, fell by 6.4%.⁸
Moving into 2023, we believe that broad U.S. dollar strength is likely behind us as Fed rate hikes are fully priced into markets. Furthermore, the impact of Mainland China’s faster-than-expected reopening could have a positive spillover to other Asian economies and currencies. We’re constructive on the following high-beta currencies to the greenback in the new year:
- The South Korean won experienced high volatility in 2022, weakening to levels versus the U.S. dollar not witnessed since the 2008 global financial crisis. While some of the currency’s weakness was due to the greenback’s strength, it was also structural: The country posted a string of large trade deficits toward the end of the year. The won could play catch up in 2023 as investors focus on interest-rate differentials as the Bank of Korea has adopted a relatively more aggressive monetary policy among Asian central banks. Mainland China’s faster-than-expected reopening with increased import demand may also serve as a key catalyst.
- Thailand’s baht experienced heightened volatility during 2022 due to fluctuations in tourist arrivals and rising energy prices. Tourism, which accounts for roughly 18% of GDP, lagged in the first half of the year as COVID-19 cases rose. Surging energy prices contributed to a rising current account deficit (roughly 3.6% of GDP for 2022), sending the Thai baht to a 16-year low against the U.S. dollar. With tourist arrivals reaching 10 million in 2022 and energy prices steadily declining, we believe the currency could be one of the outperformers in 2023.
After the storm of unprecedented challenges in 2022, we believe Asian fixed income is positioned to move from being the bearer of headwinds to the beneficiary of tailwinds. The recent rebound in the asset class—supported by Chinese policy stimulus and a faster-than-expected reopening—should be a key catalyst to watch in the new year.
Overall, we see attractive risk-to-reward opportunities among certain segments in the asset class. Higher Asian corporate bond yields could provide investors with relatively attractive entry points from a total return and income perspective. We believe that bottom-up credit selection will be the key driver in generating further returns going forward. Asian currencies are also poised for better performance with a weakening U.S. dollar and resilient regional growth prospects.
1 Bloomberg, as of December 30, 2022. 2 Bloomberg, as of December 30, 2022. 3 Bloomberg, as of December 30, 2022. The J.P. Morgan JACI Investment Grade Index was used as proxy for returns on Asian investment-grade credit. 4 Bloomberg, as of December 30, 2022. The J.P. Morgan JACI High Yield Index was used as a proxy for returns on Asian high-yield bonds. 5 J.P. Morgan, as of December 30, 2022. 6 The policy initiative was widely known as the three arrows because they aim to improve sentiment through bank credit, bond issuance, and equity issuance. 7 The International Monetary Fund, Bank Indonesia. 8 Bloomberg, as of December 30, 2022.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may a