Asia Rates: Flows, Positioning & Valuation (June 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
For charts and models referenced in report, click Download the PDF.
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.
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.