Asia Fixed Income Investment Outlook – Quarterly Update

Author: Chris Lau, Senior Portfolio Manager, Invesco Fixed Income

Trade tariffs have remained a key driver of market volatility and market fluctuations in response to various headlines are almost a daily occurrence. The US announcement of reciprocal tariffs on April 2 came as a major negative surprise, triggering a broad sell-off in global risk assets and a rally in US treasuries. Ongoing uncertainty and challenging market conditions dampened investor risk appetite, leading to wider credit spreads.

Within the Asia investment grade (IG) space, India and Indonesia IG credits experienced notably sharper declines during the initial sell-off, underperforming their regional peers. Japan insurance and Australian bank subordinated debts also lagged, primarily due to crowded positioning, as the correction reflected prior investor overweights.¹ Whereas while India underperformed as well, additional pressure stemmed from military conflicts with Pakistan, prompting heightened caution toward issuers with assets near the conflict zone.

We then saw a de-escalation in tensions between the US and Asia/China following a 90-day truce of implementing tariffs. The market breathed a sigh of relief, and Asia credit markets recovered most of their recent losses. The Asia investment grade (IG) credit market has exhibited resilience despite a challenging environment and registered a positive return of 2.13% year-to-date² supported by strong technicals and yield carry.

The spikes in market volatility and widening of Asia credit spreads since the announcement of Trump’s Liberation Day” tariffs on April 2 have come full circle. JP Morgan Asia Credit Index (JACI) IG spreads have widened from +76 basis points (as of Feb 28, 2025) to +111 bps (on Apr 7, 2025) and fully retraced the widening to +84bps (as of May 16, 2025) (Figure 1). Spread performance, however, exhibited notable divergence across individual countries. Indonesian and Philippine IG were notable outperformers, with spreads tighter than levels prior to “Liberation Day”. Technicals have been extremely strong despite rich valuations and escalated rates volatility.

In the US, trade tariffs have increased the risk of a US recession. Economists have lowered growth forecasts for the US economy, raised inflation forecasts, and increased 12-month recession probabilities. Business and consumer surveys are pointing to slower growth and a gloomy outlook, which highlights potential vulnerabilities in US consumer spending and the labor market. However, the Fed has signaled that it will be patient before acting and needs to see hard data that shows softness.

Optimism returned to market as of mid-May as we saw a thaw in US-China relations which helped to lower recession risks. However, the macro backdrop deteriorated again when Moody’s cut the US sovereign credit rating down one notch to Aa1 from AAA, citing the growing burden of financing the budget deficit and rising interest costs. The decision lifted treasury yields to reflect more risk and further dampened sentiment towards owning US assets. US treasuries were already facing a growing pile of debt and less foreign demand in early April when treasury yields rose and the dollar weakened in reaction to Trump’s initial tariff announcement. We are seeing signs that investors are considering shifting away from US dollar-denominated assets. Investors are increasingly seeking alternatives in the other developed market (DM) currencies or regional local currencies as they expect the sell-off in the dollar to continue. The Asian credit market is already feeling the effects of de-dollarization, and the trend is expected to reshape regional financing dynamics.

We expect emerging markets (EM) Asia economic growth to be impacted by the trade tariffs. The market is adopting a wait-and-see approach with limited conviction following the 90-day truce. Generally, economists have reduced their GDP forecasts across most regional economies, but they expect the Asian countries to remain resilient, supported by accommodative central bank policies and benign inflation. The outlook for Asian IG issuers remains constructive for 2H 2025, with expectations of resilient credit fundamentals amid slower global growth. Despite tariffs from the US, Asian corporate and bank credit fundamentals are expected to remain resilient though earnings growth may see a negative impact. In addition, the leverage ratio for Asia IG corporates remains relatively low. Lower local rates are likely to ease overall financing costs. Prudent balance sheet management continues to provide buffer against potential economic headwinds.

Valuations are once again close to historical tights from 2024 levels (Figure 2). The only period when spreads have been tighter than current levels for an extended time horizon was during 2024 when the macro backdrop was benign, with steady global growth, low recession risks, and gradually falling inflation. Despite the easing of trade tensions, we argue the macro conditions are unlikely to return to the “Goldilocks”-like conditions that characterized much of 2024. Therefore, we foresee little room for spreads to further tighten from current levels.

Despite the fiercest tariff talks with the US in recent history, we are turning more constructive on China IG as we expect the economy to stabilize and companies to benefit from the government’s easing policy and fiscal stimulus. We expect growing interest in China credit, which is mostly due to 1) strong supportive technicals, and 2) expectations of more easing by China policymakers to stabilize the Chinese economy.

In conclusion, we anticipate US interest rate volatility to remain elevated in 2H 2025, reflecting ongoing uncertainty around the debt burden, US treasury supply and declining demand. The tariff discussion and US rates will continue to exert a dominant influence on the asset class. However, Asia IG credit is expected to remain resilient, supported by accommodative regional central bank stances and solid fundamentals across major Asian economies. We expect credit spreads to stay volatile as well with the continuous headlines. Whilst yield carry continues to be attractive, managing tail risk is important, and it is important to stay up in credit quality. We expect opportunities will emerge in the coming months but maintain our relative defensive stance.

Author: Norbert Ling, Portfolio Manager, Sustainable and Impact Investments, Invesco Fixed Income

We saw a V-shaped recovery in Asia high yield (HY) markets between the start of April and May 2025, which also reflects the limited direct tariff impact for this asset class. Year-to-date excess returns for Asia HY are positive with total return at 2.7% (Figure 1).³ Asia BB yields are currently higher than 2023 total returns. While returns were also very strong in 2024, we still expect income to be the core driver of returns going into 2H. We also highlight that select B-rated bonds can provide the incremental income that can possibly be an additive boost to overall portfolio yields, without taking excess credit default risks.

Heading into 2H 2025, we highlight the following topics that we think would be of interest to investors looking at the Asia HY asset class.

Default rate expected to remain low for Asia HY (excluding real estate)

At the end of April 2025, we witnessed the second default of a restructured China real estate developer and its subsequent departure from the J.P.Morgan Asia Credit Index (JACI) benchmark once again. It is evident that the debt burden remains too high for some of these China high yield real estate names that already undertook a first round of offshore debt restructuring. Another key takeaway is that the recovery value in such restructuring exercises is driven by the conversion price set within the convertible bonds which remains a key negotiation obstacle between the controlling shareholder and creditors. Lastly, we note that restructured bonds with an equity option embedded, be it in a convertible or mandatory convertible bond format, are not eligible to be part of the JACI index.

For 2025, we expect default rates in Asia HY (ex-real estate) to remain low, as evidenced by Figure 2 which shows a very small universe of bonds within the Asia HY index that trade at distressed levels of yields (which we define as having spreads of over 1000 basis points). From a sectoral perspective, Asia HY has limited exposure to oil and gas sectors and there are also several commodities issuers that are positioned at the lower end of the cost cash curve which are more resilient in times of lower commodities prices. In addition, we continue to see Asia HY bond issuers taking proactive early measures to refinance upcoming debt maturities or securing bank facilities to refinance them. As such, we remain constructive that default rates outside of the real estate sector will remain low for the rest of 2025.

Asia high yield continues to provide abundant income opportunities for fixed income investors in diverse sectors

Within the Asia high yield asset class, we prefer bonds that yield between 8 to 10% as these provide good total return opportunities without the volatility of equities in terms of multiple risks including earnings revision risk. From a sectoral perspective, we continue to favour subordinated financials, secured first lien bonds with renewable or infrastructure assets, as well as the Macau gaming sector. These sectors are not directly impacted by tariffs and are instead more domestic focused and arguably have been battle tested during the Covid shutdown period. In addition, we believe emerging market (EM) frontier sovereigns do offer unique alpha opportunities in various macroeconomic scenarios, where continued progress on IMF⁴ structural reforms on tax collection measures can pave the way for improved credit ratings.

Please also refer to our Q2 outlook where we highlighted the importance of coupons, which remains a core thematic.

Asia BB has limited yield pick-up versus BBB yields, hence it is important to focus on name selection rather than beta overweight as a strategy

Asia BB-rated bonds continue to provide a yield pick-up versus BBB, but this differential is around 120 basis points only which is at the lower bound of the 5-year average, while recovering from over 200 basis points at the peak of the April market sell-off (Figure 3). We still see all-in yields as attractive in the BB space but would advocate for very specific name selection in improving credit stories that have spread tightening potential, rather than an outright overweight on BB-rated names.

In this vein, we believe that an Asia bond strategy that can flexibly allocate between BBB and BB paper according to fundamental and valuation factors is best placed to harvest credit risk premium in Asia credit markets and generate resilient income. 

Author: Yifei Ding, Senior Portfolio Manager, Invesco Fixed Income

While the market volatility in Asian hard currency and local currency sovereign bonds in April 2025 was significant, the selloff didn’t last long, and recovery was swift and strong. By mid-May 2025, Asia hard currency sovereign and quasi-sovereigns saw their spreads return to late March levels, which were close to the tightest seen over the past five years (Figure 1).

There are some merits in the current market pricing of Asia emerging market (EM) credit fundamentals, as the Chinese government among other Asian governments has already rolled out more domestic stimulus policies to pre-empt potential downside shocks from the trade fallout. Local Asian central banks have also not shied away from enacting easing monetary policies. These policy tailwinds along with still robust economic fundamentals in the region provide good justification for the relatively tight credit spreads.

However, we believe that recent geopolitical developments have led to a rise in market risk levels. Although the tariff rates announced on “Liberation Day” have largely been pushed back by another three months, global investment spending has already and will continue to be impacted negatively. We are seeing signs of slower growth in the US and expect the Federal Reserve (Fed) to be stuck between managing lower growth and higher inflation in the coming quarters. We will only get more clarity on how each local Asian economy has been doing after the initial tariff shock wears off and backward-looking data gets released in the coming months. We have a high conviction that the data will be softer. 

We remain cautious given the current divergence between Asia credit spreads and US policy uncertainty (Figure 1) and are therefore more risk averse when considering Asia hard currency sovereign and quasi-sovereign bonds.

Valuations in Asia local currency government bonds have been tight, and we have observed lower nominal yield levels in recent years. The J.P. Morgan GBI-EM Broad Diversified Asia Yield to Maturity has reached the tightest levels since Q1 2021 (Figure 2). Considering the index included Indian government bonds that are in general yielding higher than most other constituent countries in 2024, the like for like comparison may show even tighter valuations. 

We are positive on Asia local currency bonds despite the lower yield levels as we believe other fundamental and technical factors continue to support the performance of these bonds, both in terms of bond prices as well as foreign exchange rates.

We have observed lower inflation in several major Asia EM countries (Figure 3). While the higher tariff rates impose inflationary pressures on the US, they will work to push down inflation numbers in export-oriented countries.

As inflation is anticipated to be less of a risk for Asian markets, we expect that local central banks will not have significant concerns with keeping monetary policy loose so long as the country’s economic growth faces headwinds. 

Apart from fundamental factors such as lower rates and lower inflation supporting Asian local government bonds, technical factors may benefit this asset class as well. We continue to see local buyers looking to add exposure since government bonds are seen as risk-free securities in the local markets. The growth of middle-class households in Asia markets also continues to foster investment demand.

On the currency front, we have seen US dollar strength fading in Q1 2025 and we believe the dollar index will continue to come under pressure. With policy uncertainty and potential recession risks in the US, we expect the de-dollarization trend to benefit some Asia local currency bond markets as well.

Combining our optimistic outlook on both bond prices and exchange rates, we are more positive on Asia EM local currency bonds over hard currency. One example is the Indian rupee denominated bond market. The Reserve Bank of India (RBI) has started cutting its policy rate since February 2025 and will likely continue in 2H 2025 as low inflation is expected to keep real interest rates at high levels.

The RBI conducted open market operations in recent months when interbank liquidity was tight to ensure a liquidity surplus so that the eased monetary policies could translate into the real economy (Figure 4). On the exchange rate, we believe the weaker US dollar will provide room for the Indian rupee to perform well along with other Asian currencies.

Among Asia EM, we think India will be one of the least impacted countries from the potential tariff headwinds. Although the Markit iBoxx ALBI India Index has already returned around 6% YTD till mid-May 2025⁵, we continue to be bullish on the asset class and expect positive performance going forward.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.