Asia Rates: Flows, Positioning & Valuation (January 2023)
- FPI inflows are returning, and investor positioning is turning less bearish on Asia
- There are dispersions beneath the surface, driven by the China reopening theme
- IndoGBs are benefitting most. For China CGBs, the worst of foreign outflows are behind us
- Funds increased their UW on China bond duration, but cut their UW on CNY FX
- For IndoGB duration and IDR FX, fund managers turned OW in December
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Risk sentiments towards Asian assets (equities, LC bonds, currencies) are staying supported on continued softness in the broad US Dollar and further declines in US rates. There is optimism that the US and Europe's recession risks would turn out to be milder than previously expected. Moreover, Asia’s growth would relatively outperform DM this year, allowing for a risk-on environment that is conducive to inflows and Asian asset performance.
When we look at recent inflows and fund positioning changes for Asian assets, investors are turning more bullish on Asia. But there has been some dispersion and China reopening is the dominant theme driving these dispersions. For 1H, we think that risk sentiments towards Asian assets will stay supported and investors should stay still positioned around the China reopening theme.
Bond and Equity Flows
For foreign inflows into Asia bonds, we have high frequency data only for the high yielders - Indonesia and India. Both are seeing larger-than-usual foreign inflows in January. Month-to-date, there has been a USD2.8bn increase in foreign holdings of IndoGBs, following December's USD1.6bn and November's USD1.5bn increases. With foreign positioning light (after many months of outflows prior), IndoGB would be a key beneficiary of the risk-on environment and carry-seeking inflows into EM. For India GSecs, foreign holdings of FAR and non-FAR bonds have risen by USD0.4bn and USD0.1bn respectively in January. GSecs likely stood out because bond yields have not fallen as much as in US or other of Asia, and thus, be seen as relatively cheap.
For China CGBs, the worst of foreign outflows are behind us. In December, foreign holdings of CGBs increased by USD3.4bn. Though there was a moderate amount of inflows, global investors are likely still hold a neutral-to-underweight stance on CGBs. The bulk of December's increase in foreign holdings could be due to passive index inflows from ongoing WGBI inclusion process (we estimate related monthly inflows to average USD3.5-4.0bn). If global investors turn bullish on CGBs, we would be expecting monthly inflows of at least USD7-8bn.
In the other parts of Asia government bond complex, Korea KTBs registered a small USD0.5bn decline in foreign holdings in December, likely due to tightening in asset-swap spreads. Short-term Thai debt securities (Treasury bills, BOT bonds) continue to see strong foreign demand in December, as a play on the potential for THB appreciation as tourism inflows recover further.
For Asia equities, we are seeing large foreign net purchases for Chinese and Korean equities in January, while inflows into Thai equities have been relatively more moderate. Focusing on Chinese equities, net purchases via Northbound Stock Connect have amounted to USD16.6bn month-to-date, representing likely the largest monthly inflows on record. To put into context, net purchases this month is more than net purchases over the whole of 2022 (USD13.4bn) and roughly one-quarter of net purchases over the whole of 2021 (USD67.3bn).
In contrast, we are seeing small foreign net sale of Indian, Indonesia and Malaysian equities in January. Some investors could have rotated out because these economies would benefit to a lesser extent from China's reopening and recovery, whether from the perspective of exports to China or inbound Chinese tourists.
Based on our valuation measures, excess risk premia in Asia bonds appear to have bottomed in September and valuations are gradually improving (becoming less rich) across the board. Valuations, are however, still relatively rich compared to one year ago (early 2022). Though the broader macro backdrop is supportive, Asia bonds' relatively rich valuations could be a limiting factor on the scope for further price gains.
Based on our tracking of EM LC bond funds, we find a few notable changes to fund positioning. In December, fund managers increased their underweight position on China bond duration to an extreme 3.4%, but they cut their underweight position on CNY FX to a smaller 1.7%. This seems reasonable, as China's reopening and recovery would be expected to drive bond yields higher (resulting in price losses in LC terms) and be near-term supportive for CNY FX. For IndoGB duration and IDR FX, fund managers turned overweight in December, after being underweight for the five months prior. IndoGBs (and IDR FX) are likely expected to disproportionately benefit and outperform from the return of carry-seeking inflows into EM.
Looking ahead, we expect fund managers to maintain large underweight positions on China bond duration, as the outlook is clearly for higher bond yields. Managers could turn less bearish on China bond duration in 3Q, when China recovery momentum in expected to peak. On IndoGBs and IDR FX, there is certainly room for managers to get more bullish/increase overweight position in the coming months, to levels that are comparable with current overweight positions for Brazil, Mexico and South Africa.
For 1H, we think that risk sentiments towards Asian assets will stay supported and the China reopening theme has further room to run. As we have written in our Annual Outlook, we are overweight Korea KTBs, IndoGBs and ThaiGBs. We think IndoGBs give the best exposure to better risk sentiments and returning bond inflows into EM. Korea KTBs and ThaiGBs could outperform around the China reopening theme, as both their economies have larger trade/tourism exposures to China.
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