Asian Investment Grade Credit Continues to Deliver Strong Returns
Policies may set the tone for all asset classes by 2025. However, central banks in Asia are expected to adopt supportive policies to bolster exports and domestic demand. In the medium term, it is believed that U.S. inflation will hover around current levels. Nevertheless, economic growth is expected to continue to slow down, providing a reasonable basis for the Federal Reserve to ease the cycle. Mainly supported by the trend of U.S. Treasury bonds, Asian investment-grade credit is expected to continue to provide strong returns in 2025.
Chris Lau stated that, despite the unclear U.S. policy and interest rate path, stable fundamental factors and strong technical factors should drive Asian credit spreads to remain tight. The reduction in interest rate volatility in the first half of 2025 should gradually attract capital inflows into the Asian investment-grade credit market. Invesco believes that Asian investment-grade credit spreads are unlikely to narrow significantly from current levels, but the high composite yield should continue to be favorable for the market's development prospects in 2025.
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Chris Lau mentioned that in recent months, global macro events have continued to dominate market performance. The Federal Reserve's unexpected 50 basis point rate cut at the September FOMC meeting, as well as China's announcement of easing measures, have been beneficial to Asian credit. However, the expected changes in the Federal Reserve's policy path have brought many uncertainties, significantly increasing market volatility. Despite the large-scale sale of U.S. Treasury bonds, Asian investment-grade bonds have still achieved considerable returns year-to-date due to the historically low spreads.
Due to the recent strong U.S. macro data, the market expects the Federal Reserve's dovish stance may weaken. It is expected that the Republicans' likely sweeping victory will push up U.S. interest rates, as the main policy initiatives proposed (tariffs, fiscal policy, immigration) will trigger inflation risks, and the fiscal deficit will expand significantly. At the recent FOMC meeting held in November, Federal Reserve Chairman Powell refused to comment on the policy agenda and the appropriate response of the Federal Reserve. He reiterated that the Federal Reserve's policy decisions will depend on the data, and since the labor market and wage growth have cooled, and inflation is gradually falling back to the target level set by the Federal Reserve, the current economic conditions still support further easing policies.
Chris Lau said that the market has significantly reduced its expectations for rate cuts. After January, increased policy uncertainties may prompt the Federal Reserve to slow down its pace of action. The federal funds futures market currently implies that the cumulative rate cut by 2025 will be less than 100 basis points. Despite the sale of U.S. Treasury bonds, Asian investment-grade spreads continued to narrow in the fourth quarter. The Morgan Stanley Asia Credit Index (JACI) investment-grade spread narrowed 27 basis points from 97 basis points (as of August 16, 2024) to 70 basis points (as of November 8, 2024). However, despite high valuations and increased interest rate volatility, Asian credit investors still prefer to hold bonds. From the perspective of composite yield, Asian credit remains attractive due to strong fundamentals and low default rates.
Economic growth in Asian emerging markets remains robust. Although exports may remain robust in the next 1 or 2 quarters due to advanced shipments, thereby prompting real GDP to remain strong, U.S. tariffs may become the main downside risk affecting economic growth in 2025. Despite the continued downward trend in core inflation, the strengthening of the U.S. dollar may pose resistance and limit the potential for interest rate cuts in Asian emerging markets. Despite the overall potential challenges faced by Asian emerging market economies, it is believed that the fundamentals of Asian investment-grade corporate credit can remain stable due to the continued deleveraging trend and ample liquidity.
Even with the increase in new bond supply so far this year, market technical factors continue to be favorable. The net supply is likely to remain negative due to the impact of bond redemptions and coupon payments. If U.S. interest rates are lowered later next year, the primary market is expected to become more active. Overall, the primary market indeed contains attractive relative value opportunities. Invesco expects that new bond supply will remain strong in 2025, led by the financial sector, while new bond supply in the sovereign bond sector will continue to lag. The primary market is expected to continue to be a focus for investors, and new bond performance and technical factors may drive market performance.
Chris Lau stated that compared to historical levels and global investment-grade credit, Asian investment-grade credit spreads are currently tight. Key areas such as Asian financial bonds, secondary bank notes, and subordinated debt of insurance companies have higher relative value. After the recent sale of interest rates, the risk premium for long-term credit has begun to emerge. However, given potential interest rate volatility, continue to favor 5-7year credit over long-term credit. In the medium term, a constructive view is maintained on Chinese investment-grade credit, and it is expected that these companies will benefit from China's easing policies and stimulus measures.
Furthermore, Chris Lau believes that the technical factors of Chinese investment-grade credit are expected to remain strong, driven by the willingness to buy domestically. Despite recent continued volatility, it is expected that the overall fluctuation of Asian investment-grade credit spreads in the first half of 2025 will not be too large. Asian investment-grade credit offers an extremely attractive yield (low fluctuation returns between 5% and 5.20%). The pursuit of composite yield will continue to drive investment funds to flow in.