Asia Fixed Income Investment Outlook – Quarterly Update

Author: Chris Lau, Senior Portfolio Manager
Asia’s credit rally continued in Q1, benefitting from upbeat macro data and continued recovery momentum. The market started with high hopes from China’s reopening, supportive housing policies from the Chinese government and lower US dollar interest rate volatility. The collapse of US regional banks and the Credit Suisse incident in March triggered a global risk sell-off and dampened market sentiment. Asia investment grade, however, has been much more resilient than the US and Europe, weathering through the recent banking turmoil relatively well. Sentiment toward Asian credit improved after central banks took decisive action to contain the banking stress. Increased market volatility and macro uncertainty has led to investors to focus more on high quality investments. Despite an initial credit spread widening, the JPMorgan Asia Credit Index (JACI) IG spread tightened almost back to pre-banking crisis level at +139 on May 24. Asia investment grade has become more favorable under the current environment.
Source: Bloomberg, data as of May 26, 2023. Past performance is no guarantee of future results.
We have seen increasing divergence in valuations among various Asian countries. While China credits have suffered from a re-pricing given the bearish Q2 growth outlook, Southeast Asian countries like Indonesia and the Philippines have almost returned to their tightest spread levels from pre-Covid. The same could be said of India. Recent softer activity data from China and the risks of more prolonged weakness, continued to pressure weaker China credits. In the absence of fiscal stimulus and monetary easing, the China reopening momentum after Covid has been rather weak, compared to the US and European economies. In addition, the pace of the housing market recovery has been gradual and slower than previous expected. The April nationwide China property sales data saw a sequential drop of 39% month-on-month, indicating that pent-up housing demand might have been frontloaded in 1Q23. The local government has been struggling to add more stimulus to support growth without the notable pick-up in land sale revenue. Property developers have faced significant funding challenges this year also putting additional pressures on market sentiment. Demand for more policy stimulus has grown following the release of a series of weak April macro data and sluggish financial market performance.
With the lingering uncertainties, we expect market participants to remain relatively conservative in their positioning until we see more clarity on macro issues. As the market enters the seasonal weak sentiment period of May to July, event risks could lead to higher volatility and negative returns for Asia dollar bonds. The risk of US sovereign default, ongoing US banking risks, and the current Fed path view leave the market with sharp repricing risk.
Nonetheless, we maintain our constructive view toward Asia investment grade in the medium term. We believe macro uncertainties and external factors should subside in the latter part of Q3. Debt ceiling concerns are expected to be resolved despite the short-term volatility caused, and we expect the path of Fed hikes to come to an end in Q3. Lower US rates volatility should benefit high quality investment and help the Asia IG outlook. In our view, long duration high quality Asia IG would be the best trades in 2H given the end of rate hiking cycle and better growth potential in Asia versus the US or Europe.
We do not see much weakness on the China macro front as deteriorating China recovery momentum has already been in discussion for some time since April. Current valuations already reflect pessimism on China’s growth outlook. We believe China has plenty of room to roll out stimulus measures if needed. We expect Asia’s fundamentals to outperform developed markets in the medium term, benefitting from China reopening. Indonesia and Philippine sovereigns have performed well in recent months, and we see both sovereigns continue to provide stable fundamentals and quality carry amongst emerging market sovereigns. Selective sector and names within Asia IG offer compelling value. However, credit differentiation becomes even more important as their valuations reflect some challenges to their credit fundamentals.
Source: Bloomberg, data as of 24 May 2023.
Asia high yield (HY) outlook for Q3 2023
Author: Gigi Guo, Credit Portfolio Manager
Along with all risky asset classes, Asia HY has been affected by the global risk sentiment changes after the Silicon Valley Bank and Credit Suisse events. Asia HY financials outperformed the developed market sub-financial space thanks to their solid credit profiles, higher deposit ratios, and stronger sovereign support. The sector rebounded quickly after the first few days of volatility alongside global HY financials.
Although non-China HY and Macau gaming names held up relatively well in the second quarter, China’s HY property sector suffered the most and has become the biggest underperformer in the space. The slowdown in China’s property sales recovery and a few negative headlines regarding single issuers have reduced investor confidence. The lack of inflows into Asia HY and a full market positioning also contributed to worsened market technicals. Asia frontier sovereigns on the other hand performed relatively in line with global risk sentiment.
Source: J.P.Morgan, data as of April 28, 2023. Past performance is no guarantee of future results.
Coming into the third quarter, apart from China property, we believe the fundamentals for Asia HY should stay largely stable. Overall, Asia HY has cheapened versus the first quarter. We believe some solid HY bonds have started showing attractive valuations, especially in the China non-property HY space, including Macau gaming. We expect Asia HY financials will continue to outperform as major Asian banks put a larger emphasis on investor relationships and the probability that AT1 papers will be called is in general higher than that of peer markets. In our view, various high yield issuers in South-East Asian countries should be able to refinance domestically. We expect technical support to stay due to lack of supply, especially for commodity exporters. We believe Macau gaming’s operating performance should continue benefit from China’s reopening and continue to improve in the third quarter. At the same time, we are cautious on China HY property due to the slowdown in sales recovery and highly technical trading momentum. Yet the space may provide some good investment opportunities in the medium term. We selectively favor Asia frontier sovereigns as each country faces idiosyncratic economic and political developments.
Asia ESG outlook for Q3 2023
Author: Norbert Ling, ESG Credit Portfolio Manager
As we articulated in our outlook piece last November, we see a few key structural trends that we expect to continue in H2 2023 and beyond. We see transition and sector specific ESG investing opportunities in the China fixed income and climate adaptation space and believe the Asian social bond market will grow further.
ESG investing opportunities in China fixed income
We believe that China’s decarbonization journey is going to be faster than expected, as we highlighted in our 2023 outlook. This megatrend is likely to continue to play out in 2023. We believe that ESG investing opportunities in China will allow investors to gain exposure to industry-specific structural growth drivers that are aligned to the country’s decarbonization goals. Invesco has partnered with Tsinghua’s Centre for Green Finance Research (CGFR) to specifically analyze the transition pathways for the high-emitting sectors in China and showcase how we identify transition leadership.
Climate adaptation themed bond issuance is well poised for a take-off
While climate mitigation remains the key focus for issuers in the Asia-Pacific region, we see a rising focus on climate adaptation now. In 2023, we have seen Chinese bank issuers issue biodiversity labelled bonds that have use of proceeds targeting forestation, water treatment and river rehabilitation amongst others. The Asian Infrastructure Investment Bank (AIIB) also issued its first ever climate adaptation bond in May 2023.

Source: Environmental Finance Bond Database, Asia-Pacific Sustainable Bond Issuance To Increase In 2023, February 2023, https://www.spglobal.com/_assets/documents/ratings/research/101572592.pdf
Social impact matters in Asia as well as finding a sustainable financing framework
ESG investing doesn’t just cover the environmental angle, social impact is at least equally as important. The concept of just transition and the requirements of investors investing in green deals for social impact metrics highlight the level of scrutiny and social footprint of investments in fixed income landscape.
Currently, there are a limited supply of social bonds available in Asia, lagging behind Europe which represented almost half of global social bond issuances in 2022 (Figure 2). However, this proportion is likely to grow. Last autumn, a HK quasi-sovereign issuer issued its first ever social bond that was part of its sustainable financing framework. The framework was linked to the organization’s ethos, with a focus on social alleviation for small and medium enterprises (SMEs), affordable housing, access to affordable basic infrastructure, and essential services. It was also accompanied by a robust impact reporting process.
We also anticipate the growth of gender bonds (also known as orange bonds), with estimates that it can help to unlock US $10 billion of gender-lens investing by 2030 and empower 100 million women and girls by 2030.1 Within Asia, it is likely that there may be a different social focus for developed Asian countries and emerging Asian countries. The former is likely to tilt more towards focusing on the aging population and affordable housing while the latter is likely to tilt towards poverty reduction.
Source: Climate Bonds Initiative, Sustainable Debt Global State of the Market 2022
Conclusion
ESG investing in Asia fixed income remains very pertinent and success can be measured by a careful selection of KPIs and specific fund objectives. Engagement remains a key pillar of ESG investing and fixed income investors play a strong role in the provision of financing towards specific environmental (climate mitigation and adaptation) as well as social outcomes. Innovation also continues at a very fast pace, as evidenced by the recent use of distributed ledger technology in sustainable labelled bonds issuance in Hong Kong’s capital markets.
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.
FOOTNOTES
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1
Impact Investment Exchange Closes First ‘Orange Bond’ at US$50m to Invest in Women in Asia and Africa – Pioneers Post, December 2022, https://iixglobal.com/impact-investment-exchange-closes-first-orangbond-at-us59m-pioneers-post/