Q3 Outlook: Riding the Wave - The Asia Investment Grade Bond at Peak Rates

  • Resilient US economy, falling inflation, favourable policies to benefit risk assets; upgrade equities to OW
  • Prefer developed markets over emerging markets; Favour US, European, Indian and Japanese equities
  • Asian Investment Grade bonds stand out; South Korean financials, China's BBB rated SOEs and TMT among top picks
  • See opportunities in Macau gaming, Indian renewable and Indonesian energy High Yields

A resilient US economy, falling inflation, as well as favourable monetary and fiscal policies are positive macro trends that will benefit risk assets, according to BEA Union Investment, who have a preference for developed markets over emerging markets. For bonds, due to their attractive yields, and as the rate hike cycle approaches its end, BEA Union Investment favours Asian investment grade bonds, of which South Korean financials and Chinese BBB rated investment grades are in focus.

US, European equities in favour as rate hike cycle near its peak

A year long-plus quantitative tightening coupled with decelerating economic growth, prices have been tapering off in the US. Excluding food and energy, core inflation softened to 4.7% in July. BEA Union Investment believes the downtrend will persist. Although the central bank raised rates as expected by 25 bps last month, we should be nearing the end of the monetary tightening policy. Stronger-than-expected economic growth, and a resilient labour market that lifted consumer confidence to 18-month high, reinforced our call for a soft landing in the US. We remain optimistic towards US equities, and believe the country's leading edge in artificial intelligence and tech will continue to attract fund inflows.

Leading indicators in Europe showed the region's macro conditions should be stabilising. Second-half GDP in the Eurozone grew 0.3% on the quarter. July inflation rose 5.3% from a year ago. Albeit inflation remains pronounced, it has been coming down for several months. Our teams believe the direction of the region's monetary policy will eventually trace the footsteps of the US', brightening the prospects of European equities.

For Asian equities, we are maintaining a "Neutral" stance. China still faces economic challenges. The country's consumer prices fell 0.3% in July from a year earlier, marking the first year-on-year descent in more than two years. The deflationary pressure shows China is lacking insufficient growth drivers. After the Politburo meeting, the authorities pledged to roll out policy support. Thus, BEA Union Investment believes any measures from China in the second half of this year will likely be targeted and specific, with possibly mild impact. Although China's second-quarter GDP came in lower than expected, its economy expanded 5.5% in the first half, which we believe is on track to reach its annual growth target of about 5%. Therefore, we remain cautious towards China's outlook. Meanwhile, we are upholding a balanced investment approach while closely monitoring upcoming data and policy changes.

Among Asian equities, we favour Indian and Japanese equities. India's intact structural growth, reasonable valuations and a 6.1% first-quarter GDP growth supported our thesis. The Bank of Japan adjusted its yield curve control with the upper limit on the tolerable band raised to +1%, a sign that the central bank aims to be conservative in adjusting its monetary policy in hope of minimising market impact. Short-term uncertainties have dissipated. That coupled with a rebound in the Japanese economy where second-quarter GDP jumped 6%, fueled our continued optimism towards the region's stock market.

In terms of sector, we had increased our allocations to South Korean and Taiwanese tech stocks early on. Since then, both markets have accumulated considerable gains and our teams have subsequently reduced our holdings.

Favour South Korea's financials and China's tech, media and telecommunications Investment Grades

Peaking interest rates could send bond yields lower and prices higher. BEA Union Investment believes now is the time to look at Asian Investment Grade bonds to lock in attractive yields and pave the way for rising bond prices when rates go down.  Although China's recovery missed expectations, the country is filled with choices when it comes to Investment Grade bonds. Our picks include tech, media and telecoms as well as BBB rated state-owned enterprises.

China's Premier Li Qiang met with senior representatives of tech majors and acknowledged the importance of internet platforms. The move was perceived by the market as a sign that the authorities are about to ease regulatory pressure on the sector after three years of crackdown. This is why we see standout growth potentials in this sector, especially across high beta, BBB rated issuers.

The Chinese government has been encouraging state-owned enterprises (SOEs) to shift their investment focus towards high-tech manufacturing technologies. Fitch Ratings indicated that while the move may increase capital expenditures, impact would be limited. In fact, if the investment plans are implemented effectively, the SOEs could see better credit ratings, and their national strategic importance improved. We believe BBB rated SOEs possess more investment potentials, and are worth looking at.

Within Asia, South Korean financials and Indonesian quasi sovereign Investment Grade bonds stand out in particular. South Korea's rate hike cycle has peaked and its bonds are trading at attractive valuations. We are optimistic towards its financial Investment Grade bonds. Its green, social and sustainability (GSS) bonds saw demand sharply outrunning the supply of new issues. From a technical standpoint, this is particularly promising. We have been looking at Indonesian bonds for quite some time. The region's quasi sovereign provides attractive yield pick up over sovereign, hence we find better opportunities in the former for the time being.

Macau gaming operator, India renewable and Indonesia oil and gas among High Yield favourites

As of end July, effective yields of Asia's High Yield bonds stood at 12.2%, higher than that of the US and Latin America, which were 8.1% and 9.5%, respectively. Modified duration for Asia High Yields was only 2.6 years. Within Asia, our teams find opportunities in High Yield bonds issued by Macau gaming operators, India's renewable energy and airport operators as well as Indonesia oil and gas as well as property bonds.

Macau gaming High Yields continue to shine. The city's gross gaming revenue grew 10% in July from the previous month. Our investment teams predict Macau gaming operators will stay resilient the rest of the year, with the potential of credit upgrades. Also undergoing a solid recovery from the pandemic is India's airport passenger volumes. The country's airport operators recorded solid cash flow, and select issuers had their credit ratings upgraded. Another bright spot is India's renewable sector, which has been receiving strong support from the government. Respective corporates are able to actively raise funds through a plethora of channels, such as equity and debt issuances, loans and asset sales.

The performance of China's property High Yields remained gloomy. Starting from the end of the first quarter, our investment teams have been bearish towards the sector and have since then sharply reduced our holdings. The country's residential new starts and investments extended their downtrends. At the Politburo meeting, the authorities acknowledged the housing sector's supply and demand dynamics have shifted, and future policies will be adjusted accordingly. Local authorities are mulling to relax certain policies to support the mass market and spur demand for housing upgrades. In the face of depressing sales and in the absence of commercial projects to secure China Bond Insurance Company's guarantee to issue onshore bonds, developers could sink into deeper financial woes, underscoring higher chances for defaults.  We expect more credit events could happen in the second half. Hence, our teams will continue to shy away from the sector.


Developed markets are demonstrating signs of recovery, reviving investors' interests and confidence towards risk assets. But the global economy is currently at a juncture, where economic health, inflationary pressure and policies of regions and countries are all heading into different directions. Any change in data trends or policies could shift the markets. Thus, when making asset allocation, it's vital for investors to consider short-, medium- and long-term market conditions and stay nimble.