2025 Market Outlook: Seizing Opportunities in Bonds Amid Uncertainties

More US Treasury volatility likely on horizon; ocus on Asian investment-grade new issuances, upbeat on Asian high-yield bonds

Trump's policies spur market uncertainties, US Treasury volatility may increase
Credit spreads of Asian bonds likely remain tight; carry trade to become key investment theme
Chinese investment-grade bond valuations lofty, Japanese dollar bond supply recovering; South Korean bond fundamentals remain sound
Favourable policies to support China's local government financing vehicle (LGFV) high-yield bonds; Indian bond valuations attractive following correction

Trump's administration is expected to influence assets positively. Credit spreads in Asian dollar bonds, particularly investment-grade bonds, have notably narrowed and are likely to remain tight. Consequently, we foresee carry trade will emerge as a prominent investment theme in 2025. Opportunities in investment-grade bonds will primarily arise from new issuance, many of which could be priced at a premium. Key markets to watch include Japan, South Korea, and China. In addition, BEA Union Investment upholds an optimistic view on high-yield bonds that exhibit solid fundamentals. China and India, along with frontier markets such as Mongolia and Pakistan present compelling investment prospects.

Investment-grade bonds

The Fed delivered 3 rate cuts last year, totalling 1%. However, it signals the possibility of only lowering rates twice in 2025, implying the Fed funds rate could ease to a range of 3.75% to 4%. As the pace of rate cuts decelerates, US Treasury yields may spike again, potentially exerting pressure on long-term bond prices. While short-duration bonds have shorter maturities, UK, US and certain Asian investment-grade short-term bonds demonstrate robust fundamentals and attractive risk/reward profiles. Furthermore, short-term bonds are less sensitive to rate movements, resulting in minimal price volatility. The ICE BofA 1-3 Year US Corporate & Government Index recorded monthly returns within a range of +/-1% most of the time in the past five years, whereas bonds with maturities of 10 years or more experienced monthly returns between +/-9%. In addition to an uncertain monetary policy trajectory, any tariff hikes imposed by the current administration on imports from countries including China could reignite inflation, leading to heightened volatility in US Treasury markets. Therefore, we believe short-duration bonds are an effective way to navigate the current rate-cut outlook.

Source: ICE Data Indices, data from 31 Jan 2020 to 31 Jan 2025

Beyond short-term bonds, we are also monitoring new issuances in Asian investment-grade bonds, given spreads have narrowed significantly, leaving limited upside potential. Our team has already taken profits on some high-beta bonds and is now waiting for opportunities to invest in new issuances.

High-quality Japanese bonds defensive in nature; South Korean bond fundamentals remain sound

Many high-quality Japanese firms issued dollar bonds in 2024, broadening their investor base and providing investors with diversification opportunities. Most of these issuers have ratings of A or AA. Sectors favoured by our team include financials, consumer staples and telecommunications. Historically, Japanese companies rarely tapped the dollar market for fundraising, however issuance has surged due to robust demand and the potential narrowing of the divergence between US and Japan monetary policies. As the US continues to lower rates while Japan pursues rate normalisation, the cost of issuing dollar debt will likely decline.

South Korea's economic fundamentals remain sound, with the government's rapid response providing support to the financial markets. Our team continues to favour South Korean dollar bonds, particularly those from the financial sector. As South Korea's onshore and offshore rates are relatively aligned, our team believes that the issuance of dollar bonds will continue and will be closely monitored.

Chinese investment-grade bond valuations hefty; China's dollar bond market reviving, new issues in focus

China's economy has recently shown signs of stabilising, and coupled with the government's steady implementation of economic support measures, investor confidence in Chinese assets is slowly picking up. However, investment-grade dollar bond spreads, including banks and state-owned enterprises, have continued to narrow and are expected to remain tight. Given the limited upside in prices, our team suggests focusing on new issuances. A major high-quality technology, media and telecommunications (TMT) firm issued US$2.65 billion worth of USD-denominated bonds last November, marking its first dollar bond issuance since 2021. Moreover, it has been reported that another major player is also considering raising funds via the dollar bond market. With financing costs easing due to declining US rates and tightening credit spreads, China's dollar bond market appears to be regaining momentum.

High-yield bonds

Asian high-yield dollar bonds demonstrate robust fundamentals; favourable conditions should support further tightening of credit spreads. While the impact of China's economic measures has yet to fully materialise, recent development indicate that defaults in Asia’s high yield sector are expected to trend down in 2025. This has caused our team to stay cautiously optimistic about China's high-yield bonds. Meanwhile, an Indian billionaire businessman is facing bribery accusations in the US; although this case has dealt a blow to the Indian bond market, our team views this correction as an opportunity to buy on dips. Additionally, frontier markets such as Mongolia and Pakistan are also favoured, each for distinct reasons.

Focus on China's LGFV high-yield bonds on policy support; Neutral on property bonds

China introduced a RMB 10 trillion financing plan aimed at tackling local government debt and supporting local government financing vehicles (LGFVs) earlier. Supported by this policy, our team is positive about China's LGFVs high-yield bonds and remains optimistic about industrial bonds benefiting from improved operations and expanded financing channels. For instance, a conglomerate recently issued US$300 million in USD-denominated bonds. Regarding property bonds, the team maintains a neutral stance; despite signs of stabilisation in the real estate sector, some developers still face liquidity challenges, leading them to defer coupon payments and extend bond maturities.

Bargain hunt in Indian quality bonds; Mongolia's fundamentals intact, Pakistan short-term bond yields compelling

The billionaire owner of an Indian conglomerate and senior officials from its renewable company are facing bribery accusations in the US; this has dampened sentiment in the Indian high-yield bond market. However, India's fundamentals remain solid, with Prime Minister Narendra Modi's strategy on infrastructure and energy investment staying on track. Following the recent market corrections, bond valuations have retreated to levels that we believe are compelling enough for us to search for bargains in high-quality bonds; new offerings are also on the team's radar.

Mongolia and Pakistan are favoured by our team for unique reasons. Mongolia is one of Asia's fastest-growing markets, driven by rising coal exports following China's reopening while the mining and renewable energy industries are likely to continue attracting foreign investment. The team is upbeat about Mongolia's high-yield bonds, including those issued by banks. Regarding Pakistan, its short-term bond yields are appealing, and the country's default risk remains low. Even if liquidity pressures arise, the International Monetary Fund (IMF) is expected to provide support.

Conclusion

Due to uncertainties stemming from current policies, the US Treasury market could experience further volatility and with Asian investment-grade bond spreads already at considerably tight levels, our team will focus on low-beta and defensive bonds, while seeking investment opportunities in new issuances from China, Japan and South Korea. Meanwhile, the fundamentals of Asian high-yield bonds remain resilient. With risk assets anticipated to remain in favour and fallen angel risk being minimal, the team remains optimistic about high-yield dollar bonds.