Asia Rates: Assessing the impact from Russia-Ukraine

Geopolitical risks around Russia could become as important as the upcoming Fed hike cycle in driving Asian rates.
Duncan Tan, Eugene Leow28 Feb 2022
  • Upward repricing of DM rate hikes to pause and UST/Bund yields biased lower from haven demand.
  • Higher oil prices weigh on Asia bonds. Possible hawkish policy turns by Asia central banks.
  • Prolonged period of uncertainty would drive greater risk premiums across Asia rates and bonds.
  • Implications for investors: Malaysia and China govt bonds offer the best profile to seek cover.
  • Implications for investors: Receive KRW, SGD IRS, pay 5Y INR OIS and OW MGS, CGB vs UW Thai LB.
Photo credit: AFP Photo

For much of 2022 to date, the global themes of rising inflation and the repricing of DM rate hike cycles have been the dominant drivers of Asia rates. The onset of the Russia-Ukraine military conflict means that the outlook for Asia rates will become more complex ahead. Related geopolitical risks could rise to become as important a driver of Asia rates as the upcoming Fed hike and QT cycle. Also, we have to consider the possible extreme scenarios (such as the military confrontation broadening to more countries) and the expected impact on our Asia rates outlook.

For Asia rates and bonds, we see three main impact channels from the Russia-Ukraine conflict. The first is via global core rates. In the near term, the uncertainty and associated risk aversion are likely to mean that hawkish upward repricing of Fed and DM rate hikes would take a pause or slightly unwind. The upside to long-term US Treasuries and Bund yields should also be capped due to haven demand.

As a result, we think that lower-yielding Asia rates (Korea, Singapore) would benefit by being biased lower alongside core rates. In contrast, higher-yielding Asia rates (Indonesia, Philippines, India) would be biased higher due to more significant widening risk premiums. For the mid-yielding markets, we expect Malaysia rates to be relatively less sensitive to core rates and China rates to be predominantly driven by domestic policy and drivers.

The second channel of impact is via higher commodity prices, particularly oil. With most of the region being net oil importers (except Malaysia), sustained periods of elevated oil prices would weaken trade and current account balances, and by extension, weigh on total returns of Asia bonds. For a more in-depth discussion of Asian economies' exposures to energy prices and the impact on Asia rates, please refer to Asia Rates: Impact from rising energy prices. Based on the joint assessment of the current strength of both oil trade balances and overall current account balances, we think that India and Thailand rates and bonds would be most sensitive and would thus cheapen more against higher oil prices.

There would also be consequences for Asia's monetary policy outlook. Higher oil and commodity prices would be inflationary and growth-negative for Asian economies. Considering that the current stance of several Asia central banks already leans neutral-to-dovish, and inflation prints are rising across the region, we think the risks are skewed towards Asia central banks focusing on greater inflation risks and turning more hawkish. In our view, the likelihood of them focusing on negative growth drags and turning more dovish is low. We would be wary of the risks of hawkish policy turns by RBI, BI, BNM and BOT and the impact on respective rate hike pricings.

The third channel of impact is via swings in global risk sentiments. While Asia has little economic and financial exposure to Russia and Ukraine, heightened risk aversion could see bond investors cut risks by indiscriminately selling EM bonds or redeeming from bond funds tied to EM bond benchmarks. That said, there is some buffer against outflow risks as foreign positioning across most Asia bond markets has been low coming into 2022.

So far, risk sentiments still seem to be holding up. Still, we cannot discount the scenario where sentiments sharply deteriorate with more punitive sanctions or more countries entering the military conflict. A swift de-escalation appears unlikely, with geopolitical tensions likely to rise steadily in the near term. A prolonged period of heightened uncertainty around the likely endgame would drive higher risk aversion and greater risk premiums across Asia rates and bonds.

In the near term, for Asia bond investors, we think that Malaysia and China government bonds offer the best profile to ride out the Russia-Ukraine conflict. As the only Asian economy with positive oil and gas trade balances, Malaysia would marginally benefit from higher oil prices via higher terms of trade. Though foreign ownership of Malaysia MGS/MGII is high (~25%), a significant portion of foreign holdings is held by foreign central banks and foreign governments, which is expected to be more sticky and less susceptible to outflows around risk aversion. China bonds would provide some defensive cover in portfolios, as China's strong BOP profile seems to offer some safe-haven characteristics to China bonds.

We have a few ideas for investors to consider to hedge against a worsening of geopolitical risks around the Russia-Ukraine conflict and higher oil prices.

1) Receive KRW or SGD IRS

If US rates fall, they will likely follow. For SGD rates, there is a high level of passthrough from USD rates movements. There is a low likelihood that BOK’s outlook could become more hawkish for Korea.

2) Pay INR 5Y OIS

INR rates are most sensitive to higher oil prices and thus a direct play on oil supply shocks (Russia could retaliate by curbing oil exports). Markets are unconvinced that INR rates can stay low on a dovish RBI.

3) Overweight Malaysia MGS and China CGB vs Underweight Thailand LB

Overweight MGS and CGB for reasons above. Underweight LB because Thailand has one of the largest oil trade deficits and BOT could turn less dovish due to higher inflation risks.

For our portfolio of Asia rates ideas, we are initiating and adding a receive 5Y USD IRS vs pay 5Y INR NDOIS. As mentioned above, INR rates are the most sensitive to oil prices. However, with RBI slow to turn hawkish and hike rates for growth reasons (thus anchoring 1Y, 2Y rates), higher oil prices would lead to more inflation risk premium around the 5Y. Beyond higher oil prices, there is also the record FY22/23 bond supply that is coming on in April. Expectations of GSec weakness and the resultant hedging activity could put disproportionately large upward pressures on 5Y INR OIS/NDOIS. We pair with a receive 5Y USD IRS to offset some of the high negative carry from paying INR rates and a slower pace of Fed hikes if geopolitics worsen. Looking at our current open ideas, we are comfortable not making any adjustments now.

To read the full report, click here to Download the PDF.

Duncan Tan

Rates Strategist - Asia

Eugene Leow

Senior Rates Strategist - G3 & Asia

Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.

The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation.  Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.  The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation.  The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.

This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.

DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. 

DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability.  18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.

DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability.  13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR

Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply.  The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.