Schroders: Asian rate divergence provides bond opportunities

The diversification available in Asian bonds is an attractive element of the asset class, but investors must remain aware of the potential to be caught out if they are not selective.

On one hand, there are several economies that have completed an additional or prolonged economic ‘cycle’ compared to the US and Europe. What this means is that, after the financial crisis, rate cuts were widespread in Western economies, but many countries in Asia actually raised rates. Now we are at a point where rate cuts are being instigated in parts of Asia, and this is where we believe value can be found. China was tightening until February this year, but the government has now started cutting rates. This loosening is positive for bonds, and we see similar opportunities in India and Indonesia.

However, there are other economies - generally the smaller and more open economies such as Hong Kong, Taiwan and Singapore - that follow US monetary policy very closely. This is imposed either by a formal peg, in the case of Hong Kong, or an informal but well-defended one in the case of Taiwan. In Singapore, where I am based, the currency follows a more elaborate basket of currencies. In all three cases, these economies effectively import the US Federal Reserve’s monetary policy. The concern we have is that when interest rates eventually start rising in the US, there will be a negative impact on these bond markets. With bond yields in Hong Kong, Taiwan and Singapore already close to or below those in the developed world, there is very little appeal for holding these bonds purely for their yields.

For European investors, the Chinese currency and bond markets provide an additional opportunity for higher yields and currency diversification. After a very small decline at the start of this year, the Chinese currency has stabilised against the US dollar. From a euro or sterling perspective, the Chinese currency has resumed its appreciation trend, helped by ongoing productivity growth.

Overall, our view is that we are seeing a recovery in Asian bond markets. It is broadly being led by the ongoing economic recovery in the US, and we are seeing Asian exports slowly pick up. They have not yet reached anything comparable to a normal recovery, but then growth in the US, Europe and Japan is currently still far from normal. Once we see a more sustained recovery in US capital expenditure, we think Asian exports will really begin to accelerate, given how highly Asia is leveraged to the global cycle. There are already some signs of improvement, but these hopes have been dashed before, so we are staying cautiously optimistic.