Opportunities in a Rate Cut Cycle: From ‘Cash is King’ to Bonds

Accommodative monetary policy helps bolster bond prices
Divergence in Asian investment-grade bond spreads offers investment opportunities
China's stimulus package supports investor sentiment, technical fundamentals of dollar bonds of Chinese issuers
US election may spur market volatility; Stay vigilant against impact on high-yield bonds
Seek opportunities to buy Asian bonds if market corrects

Rate cuts to benefit Asian credits; Be mindful of near-term trends in high-yield bonds as US Election may spark volatility
In September, the Fed delivered its first rate cut in four years, shifting its objective from solely combating inflation to re-emphasising its dual mandate of price stability and maximum employment. Going forward, BEA Union Investment expects the interest rate trajectory will predominantly hinge on the US labour market. Given that US real interest rates remain considerably high, we predict the Fed funds rate could drop to around 3%, indicating a potential 200-basis point reduction over the next two years. Given the inverse relationship between rates and bond prices, a decline in interest rates could bolster bond prices. Our teams will seek opportunities to slightly extend the duration of our portfolios, given the potential for higher bond prices during this rate-cutting cycle. Falling rates expectations, easing new supply, and manageable fallen angel risk will bode well for the technical fundamentals of Asian investment-grade dollar bonds. China's USD-denominated bond market receives an extra shot in the arm after the authorities unleashed a slew of economic support measures that surpass market expectations. For Asian high-yield bonds, while the asset class continues to demonstrate solid fundamentals, we are adopting a prudent stance towards their short-term trends due to potential market volatility, although we remain optimistic about their long-term prospects.

China's policy stimulus buoys sentiment; Market volatility presents spread opportunities in investment-grade bonds
Amid market fluctuations, Asian investment-grade bonds are displaying notable spread divergence across sectors and ratings, offering investors diverse investment opportunities. For example, spreads of A-rated bonds have compressed significantly, whereas those on BBB-rated bonds remain wide, presenting an appealing investment case.

Asian investment-grade bond credit spreads

In late September, China put forward a RMB 1 trillion stimulus package that included lowering interest rates, mortgage rates, reserve requirement ratios, and introducing new instruments to bolster the stock market. We see these measures as positive for sentiment and technical fundamentals, especially for investment-grade bonds issued by Chinese asset management companies, technology, media and telecommunications (TMT), and high-beta privately-owned enterprise (POE) names. However, given China's still murky macro outlook, our teams remain prudent regarding POE firms with weak credit fundamentals. Currently, China's TMT sector continues to demonstrate stable credit qualities and generates consistent long-term cash flow. TMT issuers with potential for credit rating upgrades are on our radar in particular, which could subsequently result in narrower spreads.

Beyond China, we favour South Korean financial bonds for their strong fundamentals and defensive nature. Due to robust regulations, South Korean banks maintain solid balance sheets and ample liquidity. Alongside the country's stable financial system, the industry effectively manages risks. South Korea is the leading issuer of USD-denominated investment-grade bonds. Recent offerings, primarily from quasi-sovereign entities, banks and brokerages -- have garnered strong investor interest, underscored by the issuers' strong credit ratings. For example, in July, a major local bank raised its AT1 bond offering to US$550 million and lowered the bond yield to 6.375%, reflecting positive investor appetite and robust market confidence in South Korea's financial sector.

Asian high-yield bonds: Low default risk, but be wary of short-term fluctuations
Inflation pressures in Asia are relatively moderate when compared to developed markets, allowing the region to implement rate hikes to a lesser extent. Companies have the options to refinance via local bond markets or bank borrowings and repurchase their USD-denominated bonds early. The dwindling supply of Asian high-yield bonds and minimal new issuance are factors supporting the asset class' performance. Currently, about 70% of high-yield bonds in Asia carry a BB rating, compared to only 50% in the US. Excluding China's property sector, the default rate for Asian high-yield bonds is below 1%, lower than the 2% in the US.

As for Asian high-yield bonds, BEA Union Investment will remain vigilant against potential short-term volatility due to the US election while maintaining an optimistic long-term outlook. The asset class is supported by stable fundamentals and offers numerous investment opportunities across markets and sectors. Many high-yield bonds issued by Indonesian and Indian companies exhibit solid credit profiles and robust cash flows. For instance, corporate debts of many Indonesian firms are maturing within the next two years, and financially sound issuers can access an array of financing channels or redeem their existing bonds early. Key sectors of focus include property and energy. For the time being, India is a major issuer of high-yield bonds in the region, presenting investment opportunities across diverse industries such as renewable energy, airport operators, toll roads, and non-bank financials, all of which are capable of generating stable cash flow. In addition to favourable structural growth potential, both Indonesia and India are seeing positive trends in interest rates, which will bode well for their economies. Indonesia unexpectedly cut rates in September, while India's central bank signalled the possibility of a rate cut soon.

Shifting gears to China, the property market remains sluggish as previous measures failed to revive declining sales. Contract sales of the top 100 developers fell nearly 27% in August year-on-year, a steeper decline than July's 19.7% drop. Nonetheless, many private enterprises have successfully managed their USD-denominated debts, while many state-owned enterprises can secure bank refinancing. We are focusing on developers who have managed to refinance and those owning commercial properties, as the latter are better positioned to secure financing. Additionally, high-quality short-term property bonds are also on our radar.

"Cash is king" as an investment strategy is approaching its end. Rate cuts are expected to enhance the price performance of Asian bonds, prompting spreads to narrow for investment-grade bonds and reducing interest expenses for high-yield bonds. However, the looming US election may induce market volatility, which could have a greater impact on high-yield bonds. Thus, a more prudent approach is warranted.