Inflation drives bond investors away from Asian emerging markets

By Karl Lester M. Yap and Marcus Wong

Bond investors are avoiding Asia’s emerging markets as the region’s resilience to the global inflation threat shows signs of cracking.

Abrdn plc has turned underweight on Asian debt and SEB AB has grown more cautious, while Goldman Sachs Group Inc sees a nascent rate-hike cycle to tackle price pressures flattening its yield curves the most in the developing world. Asian sovereign bonds are among the worst performers in a gauge of local-currency debt, with some saying the pain is just starting.

“We are becoming wary of Asian bonds on the deteriorating inflation backdrop,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Even though domestic demand in the region is still recovering, the inflation backdrop will prompt even the most reluctant central banks to tighten.”

While it’s been a terrible year for investors in local-currency debt amid intensifying global price pressures, Asian bonds have born the brunt of the losses. Even a mini rebound over the past month has mostly bypassed the region: Securities from Central Asia are the only group to have lost money, while those from Asia Pacific have trailed peers in Latin America and Africa, data from a Bloomberg index shows. Only debt from conflict-mired Eastern Europe has performed worse, and a recent spate of inflation data that’s surprised to the upside is set to worsen Asia’s underperformance.

Countries seen to be late to enter the rate-hike cycle are being punished.

India’s decision in February not to raise borrowing costs on a wager inflation will slow proved short-lived and the country was forced to opt for 90 basis points of tightening. Its shorter-end yields are showing investors’ impatience with the pace, jumping one percentage point since the start of May. Similar yields in Thailand climbed 70 basis points in the same period as the nation hasn’t raised rates since 2018.

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Global institutional investors, who had been bullish on Asia at the end of last year amid expectations for a growth recovery, are turning skeptical. The region’s fixed-income market scored a 6 per cent net sentiment rating in HSBC‘s June emerging-markets survey, compared with 31 per cent for Latin America. Asia’s score is down from 16 per cent in March.

Asia pressure

Supply-chain bottlenecks due to the lockdowns in China are exacerbating inflation pressure in the region, as China is the dominant trade partner for many Asian nations.

Thailand’s inflation accelerated to 7.1 per cent in May, faster than the 5.9 per cent gain predicted by economist and the quickest since 2008. In Indonesian consumer prices rose at the quickest pace since 2017 in the same month, while inflation in South Korea has exceeded economists’ estimate every month since January.

By contrast, there are some early signs inflation may be close to topping out in Brazil and Mexico.

“Inflation will peak last in Asia,” said Edwin Gutierrez, London-based head of emerging-market sovereign debt at abrdn, which oversees about $677 billion.

That uptick in inflation is pushing the region’s central banks to act, joining their peers in Latin America and Eastern Europe in raising rates to combat price pressures.

India’s central bank finally signaled more rate hikes are coming after delivering a second-straight increase last week, while at least two more moves are on the cards in the Philippines after policy makers raised rates for the first time since May 2018. Malaysia also boosted borrowing costs for the first time in four years last month.

Even Asian central banks which have yet to join the global tightening cycle are now under pressure. Bank of Thailand has signaled a hike is coming after inflation hit a 14-year high and Bank Indonesia is expected to raise rates in the next few months.

“Upside revisions to inflation forecasts in emerging-market Asia are starting to catch up with the rest of emerging markets,” Goldman analysts led by Kamakshya Trivedi wrote in a June 8 report. “Given the more dovish posture across emerging-market Asia curves, this has translated into a persistent rates underperformance in recent months.”