Outlook 2019 - Asian Fixed Income: Coupons to keep us afloat

Outlook 2019 - Asian Fixed Income: Coupons to keep us afloat

Given our volatile outlook in most emerging market rates and foreign exchange in 2019, we will focus on income generation in Asian USD bonds, and be tactical on allocations to local bond markets.

1. We expect value to emerge amid turbulence in the market, especially in selected High Yield names.
2. A downside surprise in the US economy could bring an upside surprise in emerging and Asian markets.
3. We are staying US dollar focused for now, while keeping an eye on local foreign exchange and bond rates, both actively and systematically through our quantitative models.

What is your investment outlook for Asian fixed income in 2019?

We are expecting headwinds on the economic front, as global growth diverges between the US and the rest of the world, and the ongoing trade war between China and the US continues.

Higher (and potentially still rising) US interest rates should lead to outflows from many emerging market currencies, which should keep volatility high in these markets, both for bond rates and foreign exchange. This will be especially severe for countries with high levels of external debts.

We would expect that the impact on China’s economy, given the ongoing trade war, will also emerge in 2019. We could see slower growth and more significant capital outflows, and this should weaken the renminbi unless the government intervenes. China’s interest rates, on the other hand, should benefit from any stimulus package from the government.

The Asian USD bond market, after a prolonged correction throughout 2018, appears to present good value, especially high yield bonds. We also expect higher frequency of credit events and defaults next year, and so remain cautious in our credit selection.

What do you think could most surprise investors next year?

Much of the expected volatility has been priced into the market, and if our concerns mentioned above turn out to be more benign, we could see a rally for which the market is unprepared.

The market expects another two to three interest rate rises in 2019. The realisation of this depends on many factors with varied degrees of relevance and predictability: US growth momentum, US and global politics and the US-China trade war.

Given the current status, there looks to be the highest number of rate rises expected by the US Federal Reserve in 2019. Should this expectation move to one or even no rise, we could see an unexpected and strong rally for both US bond rates and local foreign exchange.

The US-China trade war is expected to draw a long shadow on the Chinese economy. If it is resolved swiftly, or the impact is more benign, renminbi and local equity markets could quickly recoup recent losses, and Chinese rates could reverse its recent downward trend.

Since Q2 2018, credit spreads in Asian USD bond markets have been widening, and are more differentiated across issuers. The surprises mentioned above could cause credit spreads to tighten, however this would result in more issuance, given the backlog of refinancing needs. A negative surprise could come from a higher than expected number of high yield defaults (or from a couple of high profile defaults), and heavier issuance despite the prohibitive high yield levels.

How do you plan to capture the best opportunities?

The portfolio is mostly allocated to what we believe to be high quality Asian USD bonds, especially in the high yield space, as this potentially ensures more stable income during volatile markets.

New issues of Asian USD bonds are becoming more attractive now, given the limited demand from the market, with higher coupons, shorter tenors and more investor-friendly structures now available. These securities could likely provide the portfolio with more stable returns for 2019 and beyond. When the market stabilises and credit spreads tighten, these new high-coupon should also give the portfolio a boost from potential price appreciation.

We are mindful of the tighter liquidity and economic conditions in 2019, and how this may negatively impact companies. The portfolio will tactically allocate into Chinese and other local bond markets when we see windows of opportunities, and will strategically increase these allocations when the market becomes more favourable.

BRYAN COLLINS is a portfolio manager based in Hong Kong at Fidelity International. He joined Fidelity in 2006 as a fixed income trader and became lead portfolio manager for Asian high yield in 2009. Prior to joining Fidelity, Bryan held a variety of roles in Credit Suisse Asset Management in Sydney, starting as a client consultant responsible for fixed income in 2000, before eventually becoming senior trader for fixed income and foreign exchange.



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