Rates divergence leads to ever bigger stress in EM Asia’s bonds

TheEdge Fri, Jun 24, 2022 12:23am - 4 days View Original


(June 23): Bonds in Southeast Asia are at risk of a selloff as the Federal Reserve’s hawkish posture pushes Central Banks in the region to hike rates aggressively.

Benchmark rates in the region are close to record lows, and policy makers will be forced to act due to the double whammy from US rate hikes and surging domestic price pressures. Investor skepticism on the patient policy stance adopted by local central banks is deepening as inflationary pressures refuse to ebb across the globe.

“The larger Fed hike raises the risks for more tightening in Southeast Asian economies, with rising domestic inflation in the region still the primary consideration,” said Maximillian Lin, Asia rates and currency strategist at Credit Suisse Group AG in Singapore. “In the short-term, we expect the selloff in Treasuries to put pressure on Southeast Asian local currency bonds.”

The following four charts highlight how regional policy rates and sovereign bond yields have increasingly diverged from the US and the implications.

1. Real Rates

Benchmark rates in Southeast Asian countries are negative after adjusting for the recent inflation prints, suggesting that policy makers need to hike aggressively. Food inflation is unlikely to ease soon and will become a bigger concern in Asia, with India, Thailand, and the Philippines recently witnessing the largest jump in food prices, according to a note from Australia & New Zealand Banking Group Ltd. last week. Investors may take their next cue from Indonesia’s June inflation data due July 1, after prices climbed at the fastest pace in over four years in May.

2. Rate Divergence from the US

A narrowing benchmark rate differential with the US -- the smallest in at least 14 years for the region except Indonesia -- will continue to constrain flows into local debt. As it is, the shrinking gap has already triggered net foreign bond outflows from Indonesia and Malaysia this quarter. Southeast Asia’s policy rate gap with the US narrowed considerably after the 75-basis point Fed rate hike last week. Another 75-basis point move may be in the offing in July.

However, rates are still at a record low in Indonesia and Thailand, while Malaysia and the Philippines have seen only a quarter-percentage-point increase so far. Bangko Sentral ng Pilipinas may hike policy rates by 25 basis points on Thursday, while Bank Indonesia is forecast to hold on the same day, according to economists surveyed by Bloomberg.

3. Curve Inclinations

Sovereign curves in Southeast Asia are still relatively steep compared to their US counterparts and even much of the emerging-market space. With regional policy makers under pressure to turn more aggressive, this will continue to prop up front-end yields and flatten the curve. Goldman Sachs Group Inc. expects emerging Asia’s curves to flatten, with one of the reasons being their excessive steepness relative to developed-market peers.

4. Declining Allure

The allure of Malaysia, Thai, and Indonesia bonds has diminished following the surge in US yields. The spread of their 10-year bonds over similar-dated Treasuries has narrowed, with the rate spread at least one standard deviation below the five-year average. Only Philippine yields have surged sufficiently to keep their spread over Treasuries above the five-year mean and the debt remains attractive amid rising dollar funding costs.

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