The interest rate hike, even though it’s only 25 basis points, is expected to be bad news for investment-grade bonds in Asia.
“We think there is likely to be at least two to three rate hikes [in 2016] and investment grade bonds will be more sensitive to the rise in US Treasury yields given their longer duration profile and narrower spread,” Arthur Lau, head of fixed income for Asia ex-Japan at Pinebridge Investments told Fund Selector Asia.
Lau expects Asian credit spreads to widen in 2016, though this could be offset by less primary Asia US dollar bond issuance.
However, based on his predictions, there is little reason to get excited about returns for high-grade bonds.
“We expect Asia investment grade total return is likely to be very low at 1-2% while high-yield will be about 5%-6% total return,” said Lau.
Volatility and RMB bonds
The devaluation of China’s RMB in 2015 was a shock for investors that previously viewed the currency as a one-way bet. Offshore RMB bond investors will have to brace themselves for more weakness in 2016.
“For the RMB-denominated bond market, it is difficult for offshore investors to maintain a substantial overweight, especially if they are funded in other currencies as the RMB is likely to continue to weaken,” said Clifford Lau, head of Asia Pacific fixed income at Columbia Threadneedle.
However, China’s bond market has seen some homegrown support. Lau notes that mainland-based RMB fund managers have been investing in the local bond market, which could lead to a tightening of spreads.
Sean Chang, head of Asian debt investment at Baring Asset Management, also sees volatility ahead.
“We expect [the RMB] to be normalized in line with other major currencies like the US dollar, euro and Japanese yen and pick up some volatility,” Chang said.
The RMB’s inclusion in the IMF reserve currency basket is expected to drive more demand, which will be positive for RMB bonds in the long run, he said, adding that Chinese government bonds offer value compared to other AA-rated sovereign bonds.
Asia US dollar bonds may outperform
Columbia Threadneedle expects the greenback to continue its winning streak, underpinning returns for dollar bonds.
“The US dollar is expected to outperform Asian currencies which will allow the Asia US dollar bond market to perform better than the local currency [bond] market,” said Columbia Threadneedle’s Lau.
While he expects more rotational outflows from the Asian local currency bond market, he is not completely bearish on the market. He notes that some local currency bonds have sold off a fair bit and there is potential for them to rebound.
Additionally, local currency bonds could get a helping hand from central banks in the region.
“Most of the Asian central banks are looking at easing policies and cutting interest rates, which is constructive for local bond funds,” he added.