While markets remain concerned about the fragility of the global economic recovery amid heightened geopolitical risks, the underlying fundamental story should remain positive, particularly for Asian bond, currency and credit markets.
Asia is in a somewhat unique position of potentially winning in both a positive and negative global scenario. If the global economy begins firing on all cylinders, investors on the sidelines might start feeling the confidence to deploy more capital into Asia, and investors that are already in Asia will begin to allocate more heavily to riskier investments such as currencies and credit.
If the economy experiences a misstep, investors will quickly retrench and a flight-to-quality will ensue, thereby benefiting government bonds. But we could also see investors redeploy capital into Asia as a diversifier to their own regions, similar to how we saw large flows from Europe over the past couple of years.
A key risk to this constructive outlook is inflation expectations. Policymakers in most Asian countries have done a “respectable” job of controlling inflation expectations despite strong growth and burgeoning commodity and food prices, but they must remain vigilant.
A sharp increase in inflation expectations could be detrimental to bond and currency prices. With inflation pushing upward, we expect central banks to continue to deploy the many tools in their arsenals, including targeted measures, such as those taken in Singapore and China to cool the property markets, as well as broad policies such as increasing policy rates and allowing their currencies to strengthen.
Against this backdrop, the Asia team at Western will remain tactical in its approach to interest rate management, continuing to favour an overall defensive duration posture, in which Western’s bond portfolios maintain underweight short-term rate positions in favour of long-term rates. The team also expects to maintain its overweight to appreciating currencies in the region.
We expect Asian currencies to benefit from several trends, including strong fundamentals, investor flows to Asia from lower-yielding markets, higher central bank rates and policymakers’ use of currencies as an inflation-fighting tool.
The positive fundamental backdrop will also support the team’s preference for Asian corporate bonds.
