Market Outlook

Asian Bond Market Review & Outlook

By Desmond Fu, Trader/ Portfolio Analyst
October 2020

Global manufacturing Purchasing Mangers’ Indexes (PMIs) continued to expand in August, increasing to 52.3 from 50.8 in July. A robust recovery began in May as the reopening of economies produced a burst in consumer goods spending, surging more than 20% in May and June. This pickup has combined with earlier forced shutdowns to depress stock-building at midyear. Capital expenditures (CapEx) recovery and business investment, however, will likely be subdued, on the back of weakness in earnings and uncertainty over the pandemic’s trajectory.

Containment fatigue is setting in, with governments correspondingly losing their appetite to continue with mobility curbs or lockdowns. The challenge will be the strain on healthcare systems even if mortality broadly remains low, as doctors gain experience with managing the disease. While there are early signs of progress on vaccines, even if challenges of effectiveness, production and delivery were overcome, COVID-19 would continue to pose risks and remain a lingering concern. Living with the virus will be the reality in the medium term. Market confidence, though, will be fundamentally underpinned by policymakers having demonstrated their willingness to do whatever it takes to prop up their economies.

US-China rivalry goes beyond whoever ends up winning the November elections on multiple fronts though the primary perceived threat is that of US’ national security with China’s technological ascendance. A Biden victory could be risk-positive given a less combative, more consultative foreign policy approach though Trump could surprise with a re-conciliatory shift once re-election is no longer a concern. Living with geopolitical uncertainty and tensions by increasing the robustness of supply chains, the diversification of production and business operations will underpin business decisions going forward.

August trade data from Greater China confirm the solid recovery in global demand this quarter, reflecting the broadening recovery in global goods demand amid the re-opening of economies. China August Trade Balance printed better than expected at US$58.93 billion (vs US$49.7 billion expected). Exports printed at 9.5% year-on-year (YoY) (vs 7.1% expected), while imports printed at -2.1% YoY (vs 0.1% expected). Pent up demand for medical equipment and electronics continue to anchor China’s exports since April, with goods trade surplus averaging US$50 billion per month. China is on track for a US$360 billion (2.5% of gross domestic product) current account surplus this year.

China’s retail sales which posted its first growth since the pandemic outbreak; headline sales expanded 0.5% in August. Industrial production also gathered momentum; growth picked up to 5.6% YoY in August from 4.8% in the previous two months. There is an increasing policy focus towards “dual circulation” first mentioned in May 14 by Xi Jinping at the politburo meeting where participants stressed the importance of exploiting the “advantages of China’s super-large market” to create a “new development pattern”, in which domestic and foreign markets boosted one another in a “dual circulation”.

Short-term interest rates have already rebounded to pre-Covid levels, guiding M2 and credit growth lower. New property sales surged 27% YoY in August, reaching their highest level in three years, despite prudential measures to curb the market. China’s property prices have to be managed by macro-prudential policies, as China’s housing prices are mostly driven by structural factors such as land auction policies, limited land allocation for residential property construction, and the inadequate public housing provided by the governments in large cities. Rising property prices though will anchor cautionary stance of People's Bank of China (PBoC) to avoid sending signals of monetary largesse. With most migrant workers returned to work, wage inflation feeding through to Consumer Price Index (CPI) inflation next year, guiding it higher to 2.8% at the end of next year, from an expected 1.8% rate at the end of this year as food price inflation still has room to decline.

The risk remains of a stagflationary environment if re-leveraging picks up in an easy monetary policy environment. This is not a base case. The significance of Jackson Hole is that the Federal Reserve (Fed) has now formally shifted away from a policy strategy that has for decades preempted labor market over-tightening and delivered undesirably low inflation with a focus on achieving “broad-based labour market outcomes.” While this could result in risking higher inflation, sizeable output gaps and structural factors driving a flat Philips curve are likely to persist. The Federal Open Market Committee (FOMC) signaled that it expects to maintain an accommodative stance on monetary policy until it achieves inflation averaging 2% over time and longer-term inflation expectations remain well anchored at 2%. In the following press conference, Fed Chair Jerome Powell stated “This very strong, very powerful guidance shows both out confidence and our determination.” The 2023 median dot cosigned this message, with the fed funds rate expected to remain at zero over that horizon.

In its latest estimate, Asian Development Bank expects Asia as a region to decline by 0.7% in 2020, the first regional contraction since 1962, with only China bucking the contraction malaise with a growth of 1.8%. However, in the aftermath of Covid, growth for developing Asia is expected to rebound by a strong 6.8% in 2021 led by China (+7.7%), India (8.0%) and Indonesia (5.3%). For now, Asia’s recovery continues to be led by exports out of North Asia, driven primarily by inventory restocking as well as medical-related demand. Taiwan’s August exports accelerated significantly, partly reflecting the impact of the US restrictions on Huawei-related tech exports (effective September 14), which boosted last-minute shipments by Taiwan exporters.

Asian economies benefit from both fiscal and monetary policy space, the only exception being India and Malaysia with higher public-debt ratios than their peers. While core inflation remains subdued in most Asian countries, headline inflation might see a spike due to oil price inflation. Asian central banks are expected to keep policy rates at current levels heading into the end of the year, even though there is clearly room for further easing with most countries having low foreign currency debt and strong current account surpluses. The policy pause is also driven on one hand by the increasing challenges with monetary policy transmission as well as the intent to maintain monetary policy space if growth conditions deteriorate.

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Copyright © 2020. Franklin Templeton. All rights reserved.

This document is based on an update from Western Asset, a subsidiary of Franklin Templeton. The views expressed are opinions of Desmond Fu as of the date of this material and are subject to change based on market and other conditions without notice and may differ from other investment professionals or from those of Franklin Templeton as a whole.

Franklin Templeton Investments (Asia) Limited and Legg Mason Asset Management Hong Kong Limited is the issuer of this document. The comments, opinions, and estimates contained herein are based on or derived from publicly available information from sources that Franklin Templeton believes to be reliable. The document, which is for informational purposes only, sets forth our views as of the date published. The stock provided is for illustration purpose only. It is not a recommendation to purchase, sell or hold any particular security. This document is not intended to provide investment advice. Investments involves risks.  Where past performance is quoted, such figures are not indicative of future performance.

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