Trump's rhetoric and rising political risk could increase market volatility which should sustain fund flow into Bonds.
We turn underweight on Asian Usd Bonds and recommend an active bond trading strategy through the primary market, credit selection, and a buy-on-dip strategy in order to gradually build up a spread premium to cushion against rising rates. A strong performance of Asian USD bonds since the beginning of this year limits prospects for further spread tightening, in our view. We also see Asian USD supply overhang and rising defaults in China as two major headline risks.
On the other hand, global reflation trade and China's improving recent macro data leads us to believe bond funds will switch more allocation to bonds denominated in currencies (RMB and AUD), previously affected by a commodity price decline. As such, we overweight Asian local currency bonds.
We inaugurated Bondcritic's first-ever issue on SmartKarma with our Asia ex-Japan bond strategy. Yes, we have been talking about rate hikes, President Trump, 2017 as a key election year, and China's twice-a-decade national congress.
Global reflation trade is positive for emerging markets as a whole, in our view. However, we believe the Trump effect could increase market volatility and skew fund flow into bonds. Though we believe Asian local currency bonds will make a comeback, we believe selected Asian USD bonds remain good value in light of rising volatility. Here are what we predict (and what to do to benefit from those predictions):
- Currency: Global reflation trade has waned but leads us to believe local currencies, especially RMB and AUD, are on the verge of making a comeback against USD after USD rally since Trump's surprise victory last November. (Overweight Asian local currency versus USD bonds).
- Rates: Rate hikes will be more gradual than most economists had thought. Key European elections and Trump-induced geopolitical risk could create greater-than-expected volatility, in our prediction. (Overweight bonds vs. equities).
- New issues: Rate hikes motivate issuers to issue now rather than later in order to save on its funding cost. Supply overhang should lead to rising yield, though on a gradual manner. (Prefer primary to secondary markets)
- Countries: Global reflation trade is positive for Asian economies. However, Trump' s rhetoric on trade restrictions could eventually hurt Asian countries with higher exports as % of GDP. Rebounding commodity prices have been priced in and we believe domestic consumer spending and self-sufficiency means stable macro in the longer term (Overweight India ( also see Das Capital Management and Advisors) , Sri Lanka, and Indonesia as top 3 countries of risk for the USD bonds). We are neutral as China's improving macro is mitigated by lingering bad debt as rising bad debt.
- Default: China's debt problem will not significantly improve, in our view, but improving macro data will lend China a temporary lifeline. Default and corporate governance irregularities, especially in China, will continue to resurface (Prefer credit selection/active bond strategy vs. passive bond strategy).
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