“Ongoing economic rebalancing in China, policy initiatives to gradually deleverage and allowing market forces to drive financial market discipline”, will test the ability of entities to meet loan obligations, particularly against the backdrop of slowing economic growth, according to Kheng-Siang Ng, head of fixed Income for Asia-Pacific at State Street Global Advisors, speaking at a recent media event in Singapore.
“The challenge of the slower economy will start to surface more in the banking sector,” he added.
There will be increasing pressure on issuers in sectors such as property, steel and mining resources and funding vehicles for financial services and products “where there is high leverage”.
These sectors will also be tested by changes in China’s policy focus, such as control of house price inflation, pollution control and reducing shadow banking, he said.
Sectors with a strong reliance on consumption, such as telecoms, retail and the services sector, will be less susceptible to defaults.
Trade dispute wildcard
China is on its way to another record year of onshore bond defaults. At least 15 defaults since the start of November have pushed this year’s total to RMB 120.4bn ($17.1bn), close to the record RMB 121.9bn set last year, according to data from Bloomberg.
Ng said he expects more onshore defaults in 2020, but default rates should not be substantially different from previous years.
In fact, China is one of his top calls for fixed income in 2020, alongside Indonesia.
He thinks that Indonesian bond returns could strengthen due to relatively attractive yield levels – around 7%.
“The yields may go down. The overall yield sentiment depends on the overall risk environment, and the trade conflict will be an issue.”
Indonesia’s easing cycle still has room to unfold, Ng believes. He expects 2-3 more interest rate cuts in 2020, depending on how the Indonesian economy responds to recent cuts.
Thailand is a different story. Its onshore 10-year government bond yields a comparatively low 1.54% and the Bank of Thailand has cut rates twice this year to 1.25%, “the lowest rate in nearly two decades”, Ng said.
“While the central bank still keeps the window open for further rate cuts should the growth outlook worsen, the central bank is expected to be more cautious” because it is rolling out fiscal stimulus.
“Hence, we believe there would be limited mileage for further big decline in bond yields given Thai bond yields are already at near record low.
“But we are not going underweight on an outright basis yet as monetary policy posture is still easy and the positive trend of current account surplus will continue to support a strong Thai baht in coming months relative to other Asian currencies.”
Philippine bonds, with a relatively high yield (4.52%), face limitations because of an expected pause in the central bank’s rate cutting cycle, he added.
In general, Asian bonds are expected “to stay well supported on the back of benign inflation and easing monetary policy stance by the central banks”, he said. However, downside risk could increase should US-China trade tensions escalate.
Under these circumstances, he has less preference for the lower yield space and is underweight Hong Kong, Singapore and Korea.
Current 10-year local government bond yields
Source: SSGA, FSA
Next year, Ng expects that Asia bonds will return better on the hard currency side than local currency. “Investors might rather stay in the dollar space given the uncertainties,” particularly from the trade tensions.
T Rowe Price recently said it sees lower Asia bond returns on average next year.
Ng concurs. “I don’t have a number on returns” for next year, he said, but added that the benefits from interest rate cuts which have been helping Asia bond returns “will not be as strong next year, compared to this year”.
The firm’s pan-Asia bond index fund follows the The Markit iBoxx ABF Pan-Asia Index. About one-quarter of the fund is in China government bonds.