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Treasury outlook

World market turns bullish on Asia's local-currency bonds

Asian central banks have turned more dovish in the third quarter of 2012, following rate cuts by China (-25bps), the Philippines (-25bps) and South Korea (-25bps).



Indonesia was the outlier, where the central bank raised the FASBI (overnight lending facility) by 25bps. Nevertheless, going forward, we expect more rate cuts in 2012 - China snipping another 25bps in Q3, South Korea another 50bps (25bps in September and 25bps Q4) and the Philippines 25bps in September.

Apart from Indonesia, the mood among Asian central banks is skewed towards dovishness ahead. Inflation pressures are generally quite tame, while the external environment continues to deteriorate. Local investors are taking comfort from the fact that central banks are easing and are buying bonds aggressively. Yield curves are inverted in several markets in Asia, such as the South Korean bond curve and the Thai swaps curve, as investors are pricing in rate cuts.

Foreign inflows surge

Foreign bond inflows have picked up considerably in Q3 of 2012, after having been fairly stagnant in the first half of the year. Extremely low or, in some cases, negative yields in several European markets are prompting a surge of inflows to Asian bond markets, where investors have generally been underweight against the benchmark for most of this year.

In Indonesia, foreign bond inflows amounted to US$1.05 billion in July compared to $164 million in the first six months of this year. In South Korea, foreign bond inflows amounted to 1.4 trillion won ($1 billion) versus net investment of -0.3 trillion won (-$260 million) in June.

In addition, feedback from investors we have spoken to recently indicates that investors were fairly overweight cash-wise going into the Greek election at the end of June. Since the event turned out to be risk-on and emerging-market (EM) assets rallied, foreign investors have been covering their underweight positions in Asian bonds. Moreover, feedback from investors suggests that several real-money accounts are still slightly overweight cash, and thus the inflows into EM assets, including Asian bonds, will continue.

Supply conditions still favourable

Asia's fiscal finances remain in good shape with government-bond raising generally ahead of run-rate for the first seven months of the year. Therefore, we see limited risk of a supply squeeze in the remaining five months of the year, as governments' balances are generally in good shape.

Asian bonds: stay long

We remain bullish on Asian bonds. We expect the Philippines central bank to cut rates by another 25bps in September, while the Bank of Korea should cut by another 50bps this year. This should bode well for the domestic bond market. In addition, the robust fiscal position, credit-rating upgrade story and strong currency plays in favour of Philippine peso local currency bonds. Meanwhile, strong foreign bond inflows (particularly from central banks and sovereign wealth funds) and positive demand-supply dynamics should be supportive of the Korean bond market.

In Thailand, we recommend switching from 10-year Loan Bonds into three-year BOT bonds. The baht bond curve is extremely flat now with the three-year BOT/10-year spread at just around 10bps. Given that we are not calling for the BOT to cut rates at its upcoming meeting, we do not see value in holding the long end.

We have a "neutral duration" outlook on Indonesia and Malaysia bonds. Bank Indonesia hiked the overnight FASBI on August 10 by 25bps, which prompted a slight upward correction on Indonesia bond yields. The Malaysian central bank is also expected to keep rates on hold this year, while the focus of investors is on the budget announcement in October and the pending general election.

Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.


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