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.