Credit: Making sense of Asia credit fragility


Individual risks have been largely contained with no inkling of a systemic spillover
Chief Investment Office21 Jul 2021
  • The reflation narrative has come and gone quickly, prompting once again a search for yield
  • Asia HY underperformed tightening in global credit spreads on spread of variants, policy tightening
  • But the underperformance is country and sector specific; unlikely to spill over systemically
  • Investors should continue to look for opportunities in Asia HY
Photo credit: AFP Photo


What goes up must come down. The great reflation narrative went as quickly as it came, ratifying our suspicions that the reflation theme might have itself been overly inflated back in March 2021. Economic analysis, it seems, comes not without a sense of irony. Since peaking right about the end of the first quarter, the 10Y US Treasury (UST) yield has declined nearly 50 bps, with the markets attributing the move to a plethora of reasons:

  1. The surprise hawkish FOMC pivot revealing earlier than expected rate hikes; More colloquially known as “removing the punch bowl early”;
  2. The aggressive spread of the delta variant, likely spilling beyond Asian confines;
  3. Supply/demand technicals in the bond market, with consensus short positions being quickly unwound, and;
  4. A resurgent belief in the secular stagnation story of the last decade – inflation may be as transitory as the Federal Reserve had warned.

Credit still largely in favour. Whichever the case, a rapid collapse in nominal UST yields has historically been unambiguously associated with risk-off sentiment. Yet credit spreads are not indicative of a climate of uncertainty. Looking across a larger sample of global credit markets, the majority have seen spreads outperform the fall in both 5Y and 10Y yields, implying that bond prices have mostly increased since end-March.

Spread products back in vogue. The market price action gives credence to the secular stagnation picture – the world would need more than just a strong rebound to exit the low growth/low inflation era of the last decade, such that a perceivably premature removal of supportive monetary policy quickly leads to a deterioration of the longer-term outlook (curve flattening). In this regard, a resumption of a hunt for yield gets underway, bidding up the prices of global credit as a result.

 

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