2024 Midyear Asia Fixed Income Outlook: Credit Selection Is Key as Uncertainties Persist

• Major central banks have been reluctant thus far to lower rates, as we expected.

• Recent support measures for Chinese property will help the sector avoid a further deflationary spiral, but we do not expect a major rebound.

• Overall credit fundamentals for Asia credits will remain stable, in our view, with default rates in Asia high yield (ex-China property) staying at low levels.

• Since potential rate cuts by the Fed are likely to be gradual, we believe investors should continue to differentiate among credits that have varying degrees of sensitivity to funding costs and currency risk.

Following interest rate hikes in the past two years by major central banks around the world, fixed income investors have been holding their breath for rate cuts to begin in 2024, thus providing a tailwind for the asset class.

These moves have largely failed to materialize in the first half of the year, however. Sticky inflation has kept major central banks, especially the US Federal Reserve, wary of loosening monetary policy too quickly. The European Central Bank’s June rate cut, the first in almost five years, is the only such move thus far. Policymakers’ reluctance to lower interest rates is in line with what we had expected and had positioned our portfolios for, in contrast to consensus expectations earlier in the year.

The ECB’s actions could herald similar moves by other major central banks, given that inflationary pressures are now easing globally. Economic data are mixed but broadly positive, with most economies showing resilience and healthy GDP growth rates. This was also in line with our earlier expectation that there would be no recession.

Asian central banks, meanwhile, have also taken a wait-and-see approach to cutting rates, which runs counter to our prior expectation that rate cuts in the region could commence even before the Fed acts. While we still expect rate cuts to occur, it has become clear that Asian central banks are unlikely to move before the Fed.

In China, where a beleaguered property sector has weighed on the broader economy following leverage curbs introduced in 2020, the government has unveiled its most significant steps yet to tackle the three-year slowdown. These include scrapping nationwide minimum commercial mortgage rates and reducing minimum residential downpayments to their lowest level in history. Beijing also plans to pump hundreds of billions of yuan to help local authorities buy unsold flats and turn them into affordable housing.

As we predicted, these policy measures have been highly targeted to manage growth and avoid any systemic or contagion risks. While we do not foresee a major rebound in China’s property sector, we view these as positive steps to reduce the risk of a further deflationary spiral.

Asset class snapshots

Asia investment grade (IG) bonds remain well anchored, with lower volatility compared to other asset classes. Unlike many similar asset classes, Asia IG has eked out a positive return year-to-date. We have seen strong issuance from South Korea as well as Japan, with the latter remaining a compelling market to invest in.

Outside of these markets, issuance remains limited, providing technical support for the asset class. The size of the region’s credit landscape looks set to shrink this year, as maturities and coupon repayments are twice the amount of new issuance. Furthermore, fundamentals generally remain solid.

Asia’s Credit Outlook Is Broadly Stable

Source: PineBridge Investments as of 31 March 2024. For illustrative purposes only. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

Asia high yield (HY) corporates (excluding China’s property sector) similarly have maintained stable credit profiles, with default rates remaining low. Negative sentiment toward this asset class due to earlier defaults in the Chinese property sector has led to attractive pricing dislocation opportunities. As a result, Asia HY has been one of the best-performing fixed income markets year-to-date, delivering 9% in total return in the first five months of the year.1

We expect fundamentals in sectors such as gaming, retail, infrastructure, and technology, media, and telecom (TMT) to continue to improve and believe corporates with cheaper local funding sources will opportunistically buy back bonds. We are cautious on the fundamental trajectory of distressed or defaulted China developers but see opportunities in a small number of likely survivors, which have large rental property portfolios and landbanks in top-tier cities.

Stay selective

Looking ahead, with the US elections taking center stage in the second half, we remain cautious on risk sentiment and trade-sensitive sectors. Since potential rate cuts by the Fed are likely to be gradual, investors should continue to differentiate among credits that have varying degrees of sensitivity to funding costs and currency risk.

We expect overall credit fundamentals for Asia credits to remain stable and for default rates in Asia high yield (ex-China property) to stay low. We favor selective industrial companies that could benefit from a stabilizing macroeconomic backdrop as well as continued improvement in local funding access.

In our view, Chinese policymakers will likely continue to drip-feed support measures focused on managing growth and downside risks, rather than launching a large-scale policy bazooka. We were (and continue to be) measured in our view of China’s growth and believe investors should stay highly selective in the property sector. Furthermore, with high-quality Chinese bond issuers likely to continue to enjoy much cheaper local funding, issuing in the US dollar bond market will be a less attractive option – resulting in continued negative net issuance.

Given the uncertain investing environment in the second half of the year, credit selection will be key. We believe a platform with deep credit research capabilities, along with the discipline to stick to a well-established investment process, can help investors tap the most compelling opportunities in Asia fixed income.