Asia Rates: Flows, Positioning & Valuation (April 2023)
- With narrowing divergences across central bank policy outlooks, 2Q is likely to be…
- …a quarter of relative stability and lower volatility in Asia macro markets.
- We see bifurcation in 2Q, where Asia's high-yielders (ID, IN) would see larger-than-usual inflows
- Fund managers moved to neutral on Malaysia duration and IDR FX, from previous small overweights
- Peaking of policy rates across US/Asia would be a restraining factor for Asia yields to cheapen
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We are forecasting most Asian central banks to hit peak policy rates and enter into pause mode by the end of 2Q, alongside the Fed and ECB. The exceptions are BOT where we expect policy rates to peak only in 3Q and PBOC where we could potentially still get a couple of MLF cuts over 2Q and 3Q. With narrowing divergences across central bank policy outlooks, 2Q is likely to be a quarter of relative stability and lower volatility in Asia macro markets. In such an environment, investors are likely to focus on carry strategies, which would favor Asia's high-yielders such as Indonesia and India. For Asia's low and mid-yielders, their short-term money market rates and longer-term government bond yields are lower than the US, and so wouldn't be attractive from a carry perspective (unless the broad US Dollar is weak).
Fundamentally, we think Indonesia's IndoGBs and India's IGBs are good options for international investors looking for quality carry (high yields relative to rates and FX vols). In Indonesia's case, there is fiscal flexibility to reduce issuances to anchor bond yields (if needed) and our more-bullish forecast for a +0.4% (of GDP) CA surplus would help to cushion spillovers from external risk events. In India's case, we expect RBI's FX intervention to cap USDINR upside and slow any breakouts from possible USD strength. We also expect RBI to manage onshore liquidity such that the liquidity position doesn't tighten too much from here and negatively impact market's absorption of IGB/SDL supply.
Bond and Equity Flows
Our forward-looking view on regional bond inflows is for bifurcation, where Asia's high-yielders (Indonesia, India) would see larger-than-usual inflows in 2Q, while the low and mid-yielders would see flat-to-modest inflows. Some investors could also underweight/short Asia's low-yielders to fund overweight/long positions in high-yielders, especially if they have low conviction on the outlook for US rates and the broad USD.
Global investors increased their holdings of India IGBs for the fourth month in April - Foreign FAR holdings increased by USD0.3bn, more than offsetting a USD0.2bn decline in non-FAR holdings. The larger-than-usual foreign buying of IGBs in recent months is somewhat at odds with the low near-term prospects for index inclusion. We think that foreign investors are buying more IGBs not as a bet on inclusion prospects, but for the carry attributes of IGBs (one of the highest yield-to-vol ratios in EM).
Foreign holdings of Indonesia's IndoGB rose in April by USD0.3bn. IndoGBs are still seeing foreign interest, but the pace of inflows have certainly slowed compared to November-January period. Our sense is that global investors see IndoGB valuations as slightly rich and positioning is less clean/light compared to start of the year. Low conviction on the outlook for US rates and the broad US Dollar also contributes to the more cautious approach towards IndoGBs. If the Fed starts to cut rates in 2H (as per market pricing), there is scope for foreign inflows to re-accelerate.
The pace of foreign outflows from China CGBs moderated in March, likely due to the 30-50bps improvement in CGB-UST yield differentials and China's growth outlook looking relatively more positive compared to rest of the world. Foreign holdings of CGBs declined by a smaller USD4.0bn in March, compared to the USD9.6-9.7bn monthly declines in Janurary and February. In the near-term, we expect outflows to persist as CGB-UST yield differentials are still in negative territory and US-China tensions could weigh on foreign interest for CGBs.
Despite continued upside data surprises pointing to a faster and stronger recovery, foreign interest in onshore Chinese equities remains lukewarm. In April month-to-date, net buys via the Northbound Stock Connect amounted to a mere USD0.3bn, compared to monthly average of USD11.5bn in November-January period. Markets appear keen to focus on the softer data points (e.g. labor) and have doubts on the durability of China's recovery beyond the reopening-led rebound.
Though tech exports continue to be depressed, sentiments towards Korea equities (high concentration of tech-related names) have been holding up - Month-to-date, there has been small net foreign purchases of USD0.3bn. Thai equities are seeing a third straight month of outflows with foreign investors net selling USD0.2bn in April, likely reflecting some position reduction due to political uncertainty around the upcoming elections. The bright spot in Asia has been in Indonesia equities where robust inflows extend for a third straight month. Foreign buying of Indonesian equities reached USD0.6bn in April, with sentiments likely supported by a few large IPOs recently.
Excess risk premia in Asia government bonds have slightly risen and valuations have modestly improved. Valuations are however still leaning rich. While 10Y UST nominal and real yields have come down in recent weeks, 10Y Asia yields have also retreated and in some case, more than typical betas would imply. As a result, Asia-US yield differentials did not widen as much as we had expected in March.
Though Asia bond valuations are rich, the peaking of policy rate cycles across US and Asia should be a restraining factor for Asia bond yields to cheapen significantly.
In March, major EM bond funds maintained neutral positions on broad EM bond and EM FX exposures. At the regional levels, funds remained UW on Asia bond (1.1% UW) and roughly neutral on Asia FX exposures.
Focusing on Asia weights, the biggest month-on-month change in bond exposure was for Malaysia where fund managers moved to neutral, from 0.3% OW in February. For China CGBs and ThaiGBs, fund managers kept large UW exposures at 3.2% and 1.8% respectively. Positioning on IndoGBs remained roughly unchanged at 0.6% OW.
For Asia FX exposures, fund managers moved to neutral on IDR FX, from 0.3% OW in February. Positioning on other Asia FX were kept roughly neutral.
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