If 2018 was a perfect storm for Asia fixed income, then 2019 could turn out to be a Goldilocks environment. Growth expectations diverged in 2018 as the U.S. enjoyed a boost from tax cuts, while macro headwinds and negative sentiment weighed heavily on Asian markets. For Asia fixed income, the intensification of the Sino-U.S. trade war and rising oil prices earlier in the year were significant obstacles. Almost anything that could go wrong for Asia bonds in 2018 did. Looking to 2019, key questions for Asia includes, “Will U.S. economic outperformance continue? Or will an easing in U.S. growth expectations make Asian bonds look more favorable in comparison?” We believe slower U.S. growth and the prospect of the rest of the world having hit bottom could pave the way for outperformance in Asia bonds next year.
Possible Positive Catalysts for 2019
Toward the end of 2018, we see signs that many of the negatives for Asia (and positives for the U.S.) may be reversing, which makes us cautiously hopeful for 2019. The most dramatic reversal has been in oil prices, which fell more than US$25 in a month after peaking near US$85 per barrel. Lower oil prices tend to benefit oil-importing Asian economies, such as Indonesia and India, as lower prices lead to stronger current accounts and less inflationary pressure, which are positives for local interest rates.
In contrast, for U.S. growth, we now see some headwinds on the horizon. First, boosts from fiscal stimulus should diminish. Second, corporate sentiment has been hurt by trade policy uncertainty, which could impact investment. Finally, the past eight U.S. Federal Reserve rate hikes could weaken more vulnerable parts of the economy. To be clear, while we see signs that U.S. growth sentiment may be coming off a high base, we do not see imminent recession risks.
Much of the U.S. outperformance is based on expectations of better U.S. growth (and better earnings and lower default rates), leaving higher risk assets vulnerable to declines. In contrast, Asian high yield spreads had already widened significantly, pricing in a very negative economic outlook. We believe the level of default rates implied by current credit spreads is higher than what the actual default rates will be. If Asian economic fundamentals stabilize and the default rate stays low, Asian credit spreads should tighten in 2019.