Investment in a Minute - Opportunities in Asian Fixed Income Amid Fed Hikes

“While the near-term macroeconomic environment remains challenging, there are still opportunities to value add through active positioning as domestic factors could drive a divergence in performance.”

- Guan Yi LOW, Head of Fixed Income, APAC

The impact of the Fed’s November decision on Asian markets

The US Federal Reserve (Fed) raised its policy rate by 75bps to 3.75% - 4.00% this month, but signalled the possibility of hiking rates at a slower pace going forward. While the rate move was well anticipated, the market was surprised by the Fed’s indication that its terminal rate may need to be higher than projected in September.

In Asia, Bank Negara Malaysia (BNM) hiked by 25bp on November 3rd and was unexpectedly hawkish in its message, explicitly signalling the need to recalibrate monetary policy settings to “pre-emptively” manage excessive demand on price pressures. Bangko Sentral Ng Pilipinas (BSP) announced plans to hike by 75bp at the next meeting on November 17th to maintain price stability by aggressively dealing with inflationary pressures stemming from local and global factors.

The hawkish stance from central banks has resulted in renewed volatility in global financial markets. The volatility affected Asian bond markets with moderate declines in Asian rates and credit markets. The performance of Asian currencies, was more mixed; while currencies such as the Philippine Peso and Malaysian Ringgit fell against the greenback, other Asian currencies were buoyed late week by hopes that China could ease its Covid containment practices.

Will volatility in Asian bond and currency markets continue?

The four consecutive rate hikes of 75bp by the Fed have triggered widespread carnage, including in Asia. Asian currencies took a beating, with the two worst performing Asian currencies this year, the Japanese Yen and Korean Won, falling by 22% and 16% respectively. Yield curves in several Asian countries are inverted, led by sharp rises in short end rates. Asian USD credit markets also recorded the worst year-to-date losses since the global financial crisis.

Despite the severe fallout, it appears that market volatility in the near term is likely to be sustained. It will take another month of US jobs data and a further two CPI prints ahead of the next Fed meeting, for the market to determine whether the Fed can hike at a slower pace in December and the fair pricing for the terminal rate in 2023.

Navigating volatility ahead

While the near-term macroeconomic environment remains challenging, there are still opportunities to value add through active positioning as domestic factors could drive a divergence in performance. For example, 10-year Malaysian bond yields are 15bp lower than the recent high in October. By contrast, Philippine bond yields are up more than 40bp from October. One of the key differences between the two countries lies in the current account, with Malaysia running a 2% surplus while the Philippines a 5% deficit. The relative weakness in the Philippines’ external balance has reinforced expectations of further rate hikes to stabilize the currency and anchor inflation.

Other current account deficit countries in Asia include Korea, India and Thailand, but we are not expecting a currency crisis in these countries.

For Korea, India and the Philippines, currency depreciation is likely to reduce import demand imminently. Korea is expected to end its rate hike cycle in early 2023 given the onshore liquidity pressures and clear signs of the domestic economy slowing. India and the Philippines will have to continue matching the Fed until domestic inflation pressures stabilize, but onshore liquidity continues to be flush with few signs of corporate balance sheet stress. We view that these markets could provide good investment opportunities for investors at various points in the next 3 - 6 months, especially when negative investor sentiment has already driven some of the rate and currency markets into relatively extreme levels.