Asia Rates: Flows, Positioning & Valuation (June 2022)

Our Flows, Positioning & Valuation monthly publication discusses Asia rates and bonds, focusing on technical rather than fundamental-based analysis.
Group Research, Duncan Tan, Eugene Leow23 Jun 2022
  • Pullback in USD rates and the USD were key to stabilization in Asia govvies in May
  • EM bond funds remain underweight Asia
  • Key underweight positions continue to be in THB and CNY duration
  • We expect fund managers to stay bearish Thai duration but pare back underweight CNY positions
  • 10Y Malaysia and Indonesia bonds screen slightly cheap while China and India bonds screen rich
Photo credit:AFP

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Market sentiments towards EM bonds are likely to have taken a hit from the Fed's upsized 75bps hike and significant upward revisions to forward rate projections. The expected timings of peak Fed hawkishness and peak US Dollar strength have likely been pushed further out. Volatility in global equity markets and heightened stagflation worries are also negative for risk appetite. Except for bonds of specific EM economies which are more advanced in their hike cycles and have significant macro buffers, international bond investors are likely to hold a cautious and neutral-to-underweight stance towards EM bonds in the near-term. In this month's FPV report, we take stock of the latest Asia bond and equity flow trends and reassess valuation and positioning metrics to see if we could be moving closer towards eventually turning bullish on Asia bonds.

Bond Flows – Stabilization in May; Large outflows expected for June

The pullback in US rates and broad US Dollar were key to the stabilization in Asia government bonds in May and several bond markets saw some improvement in flows from the sizable outflows in March-April. Foreigners reduced holdings of Indonesia bonds by USD0.8bn in May, a smaller reduction than the USD1.2bn seen in April and USD2.9bn in March. Across India FAR and non-FAR bonds, there has also been a similar moderation in foreign outflows (foreign holdings fell by a smaller USD0.4bn in May). Direction of change in foreign ownership of Malaysia MGS/MGII bonds turned positive in May with a small increase of USD0.1bn.

South Korean bonds saw its streak of rising foreign ownership extend for a seventeen straight month - USD1.5bn increase in KTB holdings coupled with a USD0.3bn increase in MSB holdings.

Deviating from the regional trend, China bonds did not see an improvement in flows in May. Foreign outflows stayed large, primarily due to a wide USD11.2bn decline in foreign ownership of PBBs. Foreign holdings of CGBs actually fell by a smaller USD2.1bn, compared to the April's fall of USD6.5bn. Foreign appetite for China bonds were likely subdued back in May, due to the considerable uncertainty around the duration and impact of COVID control measures on economic activity. CNY volatility likely also contributed as we believe most foreign investors consider China bonds on an unhedged basis.

Outside of Indonesia and India bonds (foreign ownership data are available at daily frequencies), data for the rest of Asia government bond markets are typically on a monthly basis and published around one to two weeks after month-end. Though we do not yet have the data for June, we can reasonably expect flow trends into Asia government bonds to worsen in June, with the possible exception of Korea KTBs/MSBs which could benefit from some safe haven demand.

Fund Positioning – Still underweight Asia

Coming into June, EM bond funds remain broadly underweight Asia. Amongst the larger country weights, for bond exposures, fund managers' biggest underweight continues to be in Thailand (2.0% UW), followed by Malaysia (0.5% UW) and Indonesia (0.5% UW). For currency exposures, fund managers' biggest underweight remains the CNY (2.7% UW), followed by THB (1.1% UW). Fund cash levels decreased further to 3.63%, from 4.83% in April and 5.86% in March.

Looking ahead, we expect EM bond funds to maintain a large underweight in Thai duration because Thai bonds offer one of the lowest yields in the EM universe. From a positioning perspective, the large underweight in Thai duration can be seen as a positive as it means that there is scope for fund managers, at some point in the future, to buy more Thai bonds to neutralize their underweight position. But for that positioning tailwind to materialize, we would need the Bank of Thailand to deliver multiple hikes and / or a rapid tourism recovery. On the other hand, we expect EM bond funds to start reducing their large underweight in CNY, primarily on the back of improving COVID situation and more optimism around China's economic outlook.

10Y Asia Bond Yield Valuations – Higher US real rates weigh

Based on our Yield Decomposition Approach (YDA), excess risk premia (valuation buffer) embedded in 10Y Asia bonds are extending their declines into June. As has been the case for much of 1H, higher US real rates were the key drag on valuation buffers in June (10Y US real yields jumped ~45bps). Rising inflation expectations have also been consequential for Thailand and Korea bonds, likely because of the larger upside inflation surprises in both economies. For higher-yielders like Malaysia, Indonesia and India bonds, excess risk premia have been materially compressed by market repricing of sovereign credit risks. Global market volatility and drawdowns in June are likely leading to wider credit differentiation between lower-rated vs higher-rated bond issuers. Our YDA approach suggests that 10Y China bonds do not offer a positive risks premia and valuations remain the richest in Asia. 10Y South Korea bonds have joined India bonds in screening slightly rich. On the other hand, 10Y Malaysia and Indonesia bonds are still slightly cheap and offer some value.

Comparing with our ARVI metrics, both YDA and ARVI agree on 10Y Malaysia and Indonesia bonds being slightly cheap. On the other hand, both YDA and ARVI agree on 10Y China and India bonds screening quite rich. At present, Asia bond valuations are clearly far from very cheap levels that could warrant turning bullish based solely on valuation considerations. In 2H, we either need to see macro fundamentals improve or higher Asia bond yields for valuations to rebound.

Equity Flows – Broad June outflows; Chinese equities the exception

Market volatility in June, driven by worries around aggressive DM rate hikes and a stagflationary global outlook, have drawn broad foreign outflows across Asian equities. South Korean equities are seeing renewed foreign selling pressures, with month-to-date net sale of USD4.3bn. Large outflows from Indian equities persist for a sixth straight month, with foreigners having net sold USD5.2bn so far in June. On a month-to-month basis, foreigners are net selling Thailand (USD0.8bn) and Malaysian (USD0.2bn) equities for the first time in 2022. Indonesian equities have been relatively resilient, seeing small month-to-date foreign outflows of USD0.1bn.

Onshore Chinese equities have been the notable exception - USD6.5bn of net purchases in June by offshore investors via Northbound Stock Connect is a large step-up from the USD2.5bn seen in May. Sentiments towards Chinese equities are likely being boosted by the improving COVID situation and the recent slew of growth support measures announced by policymakers.

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

Duncan Tan

Rates Strategist - Asia

Eugene Leow

Senior Rates Strategist - G3 & Asia


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