Spotlight on Asian credit markets

The Asian USD credit market has grown substantially in recent years, with the total amount of outstanding bonds in 2019 close to USD 1tn, compared to less than USD 200bn in 2008. The number of issuers also increased fourfold to about 600 over the same period.

May 29, 2020

By Zhu Lei and Adrian Chee

This large expansion of the Asian credit universe is driven by the debut of many Chinese issuers, which account for more than half of the market at present. Thanks to the multiple-notch uplift in credit ratings by a number of Asian sovereigns over the past decade, the overall quality of Asian credit has reached BBB+, which is 1–2 notches higher than the rest of the emerging markets (EMs).

Figure 1: The size of the Asian USD credit market has grown substantially in recent years

Source: JP Morgan, Credit Suisse as of December 2019

Figure 2: Positive credit trend in Asia over the last decade

Source: Bloomberg, Credit Suisse, as of April 30, 2020

Asian credit markets have experienced a sharp recovery over the last few weeks as the Fed backstopped the US government and corporate debt market and investors turned their focus to the gradual reopening of major economies. Asian credit spreads have tightened almost 70 bps from the widest level seen in March, with non-investment grade bonds outperforming investment grade bonds. Primary bond market activity in Asia came back to life with around USD 23.6bn of new issues printed in April versus USD 8.1bn in March, which included Petronas’ USD 6bn bond sale. The strong performance in April has brought the year-to-date total return of the Asia IG and HY indexes to 1.7% and -5% respectively, slightly underperforming US IG (2.3%) but outperforming US HY (-9%), EM Sov IG (1%), EM Sov HY (-14%) and European AT1s (-6%) indexes.

In the current environment we see value in investment-grade bonds and high-quality non-investment-grade names, on a risk-adjusted basis. The current Asian credit spread of 385 bps, which is not far from the record levels seen during the European sovereign debt crisis a decade ago, indicates that valuation is still attractive. With funding costs moving lower (1M Libor below 20 bps) due to the Fed’s interest rate cuts, the carry trade that allows investors to borrow funds at a lower cost and to buy higher yielding bonds is expected to be increasingly popular and will lead to further spreads compression in the near term.

Figure 3: JACI spread has widened to a level last seen during the European sovereign debt crisis

Source: Bloomberg, as of April 30, 2020

Figure 4: 1M Libor rate has moved significantly lower since the Fed's rate cuts

Source: Bloomberg, as of April 30, 2020

That said, investors need to be selective in their choice of sectors and issuers. It is prudent to stay underweight on highly cyclical industries that are vulnerable to Covid-19 shock, as well as emerging market countries that rely heavily on oil/gas exports and tourism. We remain cautious on the Oil & Gas sector as oil prices may stay low for a prolonged period due to lack of global demand, and such issuers and sovereigns around the globe are expected to face downgrade/default risk pressure. Relatively speaking, Asia has low exposure to the oil and gas sector compared to other EMs and the US market. We therefore expect Asia to have the lowest default rate compared to the US and the remaining EMs this year. Additionally, we are focusing on selected high-quality non-investment grade names that are mispriced and more likely to withstand the current challenging macro environment.

Our view on duration is neutral. Interest rates are expected to stay low amid short-to-medium-term disinflationary pressures and contracting economic growth. The current level of Fed fund futures suggests that the Fed’s near-zero interest rate policy will hold until 2023. Still, interest rates may come under upward pressure if inflation expectation improves on better economic data.

Additionally, the US Treasury Department is expected to sell at least USD 3tn net debt between April and June to support an economy entering a recession caused by Covid-19, which suggests high supply risk in the treasury market in the near term. A larger than expected supply of long-dated treasuries has already put pressure on the back end of the treasury yield curve – the spread between 10-year and 30-year yields has steepened to 70 bps, a level not seen since 2016.

In our view, an average investment grade Asian credit strategy with moderate duration position should deliver an attractive risk-adjusted return in a period of continued volatility and market dislocation. Asian credit markets have proven to be resilient in this period of extreme volatility in comparison to global risk assets thanks to strong local bids. Also, Asian credits offer significant yield pickup over developed markets such as the US in a low-yield environment. As such, we expect to see more inflows into Asia from global investors who are seeking diversification and relatively higher-yielding bonds in the context of their global asset allocation.

Figure 5: Asian bond markets offer a risk-adjusted yield pickup over developed markets

Source: Bloomberg, as of April 30, 2020

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