Asia Rates: Flows & Valuations (April 2022)
- The trend of foreign inflows into ASEAN vs outflows from non-ASEAN extended into April.
- In March, most Asia bond markets witnessed large foreign outflows.
- Foreign holdings of China CGBs fell by USD8.2bn in March, exceeding February’s declines.
- Though 10Y Asia yields are much higher in April, bond valuations have deteriorated.
- China and India’s bonds have turned rich while Malaysia, Korea and Indonesia’s bonds stay cheap.
For charts and models mentioned in report, click here to Download the PDF.
April's US nominal and real rates trend are not conducive for foreign demand and inflows into Asia local currency government bonds. Faster-rising US Treasury (UST) nominal yields are reducing the relative attractiveness of Asian carry - Month to date, 10Y Asia-US yield differentials have already tightened 20-35bps. In the current context, where growth outlooks are being revised lower across the globe amidst global USD strength, prospects for EM Asia duration and currency gains are likely to be judged as low and insufficient to compensate global bond investors for the reduced carry. On US real yields, 10Y have surged 50bps in April and turned positive. Such sharp upward moves historically correlate with poor foreign inflows into Asia because it reflects hawkish repricing of Fed expectations. This report looks at recent foreign inflows into Asia equities and local currency government bonds to assess if they are indeed declining.
Since our March report, Asia ex-China local currency government bonds have significantly sold off, but it does not necessarily imply that valuations have cheapened. The reason is that bond-related risks have grown over the past four weeks, whether it is the Fed signaling an earlier start to balance sheet normalization, Asia inflation continuing to surprise to the upside, or the outlook around Asia's external balances appearing to be weakening. We have updated our bond valuation models by adjusting for recent increases in risk factors to assess if Asia bonds have cheapened or richened in April.
Equity Flows – ASEAN vs Non-ASEAN Split
The Asia trend of foreign outflows from East Asia/India equities contrasting with inflows into ASEAN equities extended into April, though the sizes of net flows are noticeably smaller compared to February and March. For China, offshore investors net sold USD1.0bn via Northbound Stock Connect in April month-to-date, much smaller than the net sale of USD7.1bn in March. In Indian equities, foreigners net sold USD1.7bn in April month-to-date, a seventh straight month of outflows. In South Korean equities, outflows by foreigners have been persistent since 2020, and this month saw net sell of USD3.0bn so far. As long as foreign investors continue to net sell Korean equities, it would be hard for us to turn bullish on Korean Treasury Bonds.
ASEAN equities are seeing more foreign buying in April month-to-date. Foreign net purchases of USD0.7bn in Indonesian equities are fairly large relative to its recent history. While net purchases of USD0.2bn in Thai equities and USD0.1bn in Malaysian equities are relatively small, the continued inflows are encouraging if we consider that foreign investors have persistently net sold these markets between 2018 and 2021.
Bond Flows – Large Foreign Outflows
As explained above, the global growth backdrop and US rates dynamics are unsupportive of foreign appetite for Asia local currency government bonds, and the latest flows data confirms that. Korean bonds are the only bond market to register an increase in foreign holdings in March – a USD2.4bn increase in KTB holdings more than offset a USD1.5bn decrease in MSB holdings. Korean bonds can be considered a regional haven, as they tend to see robust inflows (likely asset-swapped/fx-hedged) during times of uncertainty and weak risk sentiments.
There were large foreign outflows from the other bond markets in March. Most notably, foreign holdings of China’s CGBs and PBBs fell by USD8.2bn and USD6.3bn respectively, the extent of declines exceeding February sizes. CGBs are likely to see foreign holdings decline in the coming months as the CGBs' yield advantage has disappeared alongside this year's selloff in global bonds and expectations of aggressive rate cuts by PBOC are now low. Global bond investors will likely consider the outperformance potential of CGBs to be much smaller going forward.
The large foreign outflows from Thailand and Malaysia’s government and central bank bonds were likely due to domestic idiosyncratic developments. Foreign bond investors cut holdings of Malaysia MGS/MGII by USD1.0bn in March, likely due to bond duration concerns post the government's announcement of a new round of member withdrawals from EPF. Foreign investors cut holdings of Thai T-Bills/BOT bonds/ThaiGBs by a combined USD3.2bn in March, the largest in many years. As we had written in the March report, earlier in the year, there had been outsized foreign buying of shorter-tenor T-Bills and BOT bonds, likely to position for tourism recovery and a stronger currency. Some of those positions likely unwound in March as the travel prospects of two key tourist groups dimmed - Russian tourists because of financial sanctions on Russia and Chinese tourists because of COVID spread and lockdowns in China.
India GSecs saw an aggregate USD1.0 decline in foreign holdings across FAR and non-FAR bonds in March and a USD0.2bn decline in April month-to-date. Indonesia IndoGBs saw USD2.9bn of decline in foreign holdings in March, though it is encouraging that foreign selling pressures are abating in April.
10Y Asia Bond Yield Valuations – Broad Deterioration
Though 10Y Asia ex-China yields are higher by 25-35bps in April (China yields higher by 6bps), our valuation approaches suggest that 10Y bond valuations have deteriorated (richen) after we account for recent increases in the various risk factors.
Our ARVI indicator points to an across-the-board deterioration in valuations in April. The extent of deterioration was largest in Malaysia, China and Thailand bonds. Notably, China and India’s bonds have now turned rich in April, from slightly cheap in March. Thailand bond valuations stay the richest due to 10Y yield levels being anchored low by BOT's relative dovishness, while bonds in the rest of Asia have, to a larger extent, adjusted to higher DM yields. Even with April's richening, Malaysia, South Korea, Philippines and Indonesia bond valuations remain cheap by our indicator. Looking ahead, we see a low likelihood of our ARVI indicator rising in the near term (i.e., Asia bond valuations improve) due to our outlook of rising Asia-US inflation differentials and weaker Asia current accounts. By extension, the scope for Asia-US yield differentials to tighten ahead is likely low.
Our Yield Decomposition Approach (YDA) draws similar conclusions as our ARVI indicator. Excess risk premia (valuation buffer) embedded in Asia bonds have declined across all bonds in April, with the size of declines most significant in Thailand bonds and relatively more modest in Indonesia and India bonds. The broad decline in excess risk premia is primarily driven by the repricing higher of US real rates and, to a much smaller extent, repricing higher of Asia sovereign credit risks and Asia fx vols. Medium-term Asia inflation expectations appear to be generally unchanged month-on-month and have not contributed to the decline in excess risk premia. In terms of rich/cheap calls, same with our ARVI indicator, our YDA approach suggests that Malaysia, South Korea and Indonesia bonds are cheap while China and India’s bonds are slightly rich. The key difference between our ARVI vs YDA calls is in the case of Thailand bonds, where ARVI sees as extremely rich while YDA sees as slightly cheap. We think the chief reason for the difference is because YDA doesn't explicitly factor in changes in Thailand's current account dynamics (which have deteriorated post-pandemic) while ARVI does. Therefore, for Thailand bonds, we are leaning more towards ARVI's call and see Thailand bonds as quite rich.
To read the full report, click here to Download the PDF.
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.