Asian bonds may suffer most if QE on ice
Bonds issued in emerging market currencies have been red-hot favourites with investors this year, garnering returns of 8.3 percent so far in 2012. But for some the happy days are drawing to a close — U.S. Treasury yields are nudging higher as the U.S. recovery gains a foothold and the Fed holds back from more money printing for now at least. That could spell trouble for emerging markets across the board (here’s something I wrote on this subject recently) but, according to JP Morgan, it is Asian bond markets that may bear the brunt.
Their graphic details weekly flows to local bond funds as measured by EPFR Global (in million US$). As on cue, these flows have tended to spike whenever central banks have pumped in cash. (Click the graphic to enlarge.)
Over the past several years, inflows have driven local curves to very flat levels, but current levels of flatness are not sustainable if/when inflows begin to slow, let alone reverse.As there is a clear correlation between the Fed’s “QE periods” and large inflows into Asian markets, we think the next few months will be difficult for Asian bonds markets (JPM writes)
JP Morgan says risks are greatest for Malaysia, Indonesia and Thailand because that’s where foreign ownership ratios are largest – in Indonesia for instance foreigners hold a third of local debt. Deficits in these three countries are also rising meaning debt issuance is rising faster than elsewhere, the bank warned. It advises clients to be underweight Asian local debt (countered by overweights in Latin America and emerging Europe)
Asian currencies face risks too –from China. The yuan is up 30 percent since mid-2005 but ended March with its first quarterly loss since 2009 and many reckon China, fearful of an exports slowdown will not permit any more big rises for now. Asian governments will have to fall into step if they want their own exports to compete. And that, JPM says, is robbing the region’s currencies of a major support anchor.
Zeitgeist check
Some more bits and bobs to capture the current mood among investors:
– MSCI’s all-country world stock index has recaptured all of its 2009 losses and is now working on recouping last year’s. It is up 6 percent for this year.
– Fund researchers EPFR Global notes investors are moving at pace out of cash into emerging market equity and bond funds. In the week to May 6 a net $3.6 billion moved into various emerging stock funds. Money market (cash) funds saw outflows of $1.6 billion.
– State Street says there has been a “sea change” in investor behaviour. In April cross-border flows that it tracks suggested the most risk-seeking investment regime since May 2008. “Institutions are buying emerging markets aggressively, adding to entrenched positions in Latin America and diversifying into emerging Asia,” it says.
– It is all obvious from the front end of the financial sector’s credit default swaps, according to Royal Bank of Scotland’s Alan Ruskin. Essentially, the hyper-stress is easing. “If financials grease the wheel that is the real economy, it is easy to see where the equity ebullience has come from,” Ruskin says.
– Merrill Lynch’s Global Wealth Management says it is still worth putting all this in context. “Equities are still 30 percent below the levels ruling on the eve of Lehman’s collapse. Some European markets have suffered much deeper falls. Implied default rates in the corporate bond markets are still more pessimistic than the worst experience in seventy years,” it tells its clients.
(Reuters photo: Goran Tomasevic)
Reuters Funds Summit: Kingdom for a horse
Anyone expecting investors to start galloping back into riskier assets in a rush might have something of a wait, according to Kathleen Hughes, who runs money funds for JPMorgan Asset Management in Europe. They are more likely to wander back in.
“Risk appetite returns in stages. It leaves on a horse but comes back on foot,” she rather neatly told a Reuters funds summit being held in Luxembourg.
There are nonetheless some signs around that show leather is getting some wear. Fund trackers EPFR Global says that although overall fund flows fell during the second week of March, there were some signs of growing risk appetite. Commodities, technology and energy sector funds as well as global emerging market equity and non-Japan Asia funds all saw net inflows.
Perhaps most noteworthy, money market funds, the bellwether for investor risk aversion, had net outflows of $381 billion in the week.
Hughes says she has seen something of the same. The size of the safest-of-safe segment of her money markets funds — the short-dated U.S. Treasury paper bit — has halved since the fourth quarter of 2008.
So there is some walking going on even if the horse remains in the stable.
(Reuters photo: Ilya Naymushin)
Desperately seeking yield
Equities may be having a stop-start kind of month, but investors do seem to be more willing to take on risk than before. The latest numbers from EPFR Global, a tracker of investment flows, show high-yield bond funds raking in the money in the second week of January. A net $766 million flowed into the HY funds tracked by the firm. At the same time, a net $578 million flowed into U.S. municipal bond funds.
The drive behind these flows is a mix of a desperate search for yield and a belief that the risk might well be worth taking. Investment grade corporate debt is considered to be priced at Armageddon levels. That is, the price assumes too much trouble ahead than is likely. This has led, for example, to a monthly record in new bond issuance in January in Europe.
High yield is not pricing in quite as extreme a default rate from a historial perspective. But it is still evidently attractive, hence $3.38 billion in global net inflows over the past seven weeks.
Municipal bonds, meanwhile, may be getting a boost from expectations for the incoming Obama administration. EPFR says U.S. investors are anticipating higher taxes, which would help municipal finances.
