Investors in Asia have been encouraged by the possibility that emerging markets could benefit from the government shutdown in the US, and are buying back into bonds from countries such as India and Indonesia that now offer attractive valuations following a sharp sell-off over the summer.
The US government shutdown means that until congress passes a budget there will be no data on nonfarm payrolls and no unemployment figures. But more importantly from an investor standpoint, the world’s largest bond market has been placed on hold.
“It’s a thorn in the side that will get thornier as the debt approaches its legal limit on or about October 17. You can furlough ticket collections at Yellowstone Park. But when you tell the world’s biggest bond market that coupons won’t get paid until nobody knows when, pretty much everything starts to fall apart,” said David Carbon, economist at DBS.
However, while this may be negative for the US, it has provided a welcome break for Asian bond investors, according to Sean Chang, head of Asia debt investment at Barings.
“For the past six months the market was very one sided but now the US has had a small hiccup people will start to revise their strategy. It provides a reality check that this is not just a one-way street and will encourage people to be more diversified,” he said.
“Things in the US will be resolved sooner or later, so for us as bond investors, time is money. We continue to look closely at valuations. Some of these countries are offering around 7% [yields] on their bonds – in particular India and Indonesia are offering pretty attractive yields.”
The Indonesian 10-year bond is yielding 8.106% and the Indian 10-year benchmark is offering 8.64% at the time of going to press.
“You do not really need to go down the risk curve into corproates, just by buying the governments you can have a handsome yield of 8% plus on the 10-year bond. But if you prefer to take a bit of risk for the premium, then some of the Indian names in USD bonds – after recent months of correction – are also quite cheap in valuations,” said Chang.
In addition, the currency is looking attractive, said Geoffrey Kendrick, head of Asian FX and local rates strategy at Morgan Stanley.
“The large rupee sell-off through the summer arguably moved the currency into undervalued territory for the first time in five years, although there has been some rebound since then. In addition, as volatility starts to edge lower – three month USD/INR volatility has already fallen from a peak of 21 in late August to 14 now – INR’s carry starts to become attractive,” he wrote in an October 4 note.
The rupee is at INR61.55 to the US dollar at the time of going to press.
Back in business
The change in investor sentiment on Asia’s twin deficit economies has also been helped in part by the US Federal Reserve’s decision not to taper its quantitative easing programme in September.
“Investor confidence in India and Indonesia is slowly returning following the Fed’s non-tapering event, and data this week suggests some improvement in current account balances and inflation,” said Joey Chew, regional economist at Barclays.
India’s current account deficit for the second quarter was better than expected, at US$21.8 billion and Chew believes it could narrow to US$10 billion in the third quarter.
“The improvement we expect means India should be able to almost fully fund its current account deficit, even without further measures to attract additional capital flows. Reduced pressure on the currency front will allow the RBI to re-focus its efforts on reviving growth amid weak core inflation,” she said.
However, longer-term investors are more cautious and argue that neither country is out of the woods, and that once tapering begins in the US, the dollar will inevitably strengthen.
“We are currently underweight local currency bonds specifically those from India and Indonesia and South Asia in general, on the anticipation that the balance of payments combined with US dollar strengthening will lead to continuing outflows from these bonds markets,” said one investment analyst at a private bank.