The $1.1 trillion Asian US dollar bond market has become a “standalone” market distinct from the rest of the emerging market fixed income universe while matching giant US markets for size.
The dollar bond market, in which Chinese issuers and investors are increasingly dominant, matches the US bank loan and high yield bond markets both of which are worth about US$1 trillion each.
Ken Hu, chief investment officer, fixed income Asia Pacific at Invesco says the Asian US dollar bond market, which is increasingly dominated by China, may also follow the path of the China’s Belt and Road initiative as countries along the route seek to finance their industrial expansion.
Hu says that the market has been dominated by three themes recently. The first is that it is growing very fast. The second, as noted above, that China is now the dominant country both in terms of new issuance and outstanding bonds in the market.
Hu says: “This is partly due to Chinese investors who have been increasing holdings of US dollars or US dollar assets. We are seeing a type of a recycling of our US dollars among the Chinese investors, along with Chinese dollar bond issuers.”
“It is now very important to get our views on China right, when we invest in this market,” Hu says.
The third is that the Asian market is distinct from the rest of the EM space behaving very differently from both Latin America and Central and Eastern Europe.
Gross issuance of Asian US dollar bonds
Hu says that one important difference from the rest of EM are very high domestic savings rates. This applies not only in China, but also in many other Asian states including Taiwan, Thailand, Korea, Singapore and Malaysia.
“If you look at the Latin America or Europe, they do not have a lot of domestic savings. Asian US dollar bonds have domestic savings to support a home bias and a China bias.
An Invesco white paper published in June suggests that the relative attractiveness of Chinese US dollar high yield bonds may also drive the performance of high yield bonds in other Asian markets.
The paper says: “In depth macro-economic research on China, systematic investment processes with respect to the onshore Renminbi bond market and an understanding of local Chinese investor behaviour have become important elements of Asian dollar bond investing.”
Another factor, addressed in the white paper is that Asia banks are constrained by greater regulatory capital requirements and so corporates are turning to bond financing including dollar bonds.
The Asian bid
The paper adds: “Asian investors have purchased over 70% of Asian US dollar bond new issuance since 2016. The so-called Asian bid is diverse, representing Asian insurance companies, banks, private bank investors and retail investors, but their shared demand appears to be based on their familiarity with Asian bond issuers and a home bias.”
Hu suggests this has contributed to lower volatility compared with other bond markets while providing strong returns.
Asian US dollar bond high yield compared with US high yield
The last two or three years have been characterised by low volatility though Hu cations investors need to be alert to major policy changes in China or potential economic turmoil.
He anticipates continued demand for Asian US Dollar bonds from European investors not least because of low or negative rates in Europe and the likely actions of the European Central Bank which should see rates stay low. Yet they do need an understanding of China.
“The European investors may need to study China, because of the Asian US dollar bond market is becoming more China dominated. They need to understand China more in terms of the domestic policies and the economic environment.”
However, he expects less interest from the US partly because issuers have enough demand from Asia and Europe and therefore may not bother with the US Securities and Exchange Commission’s 144A process.
Belt and Road may see more frontier markets issuing US dollar bonds
Hu paints a picture of a market that has changed significantly with some countries retreating from the market but with the promise of new issuers in frontier markets some driven by the Belt and Road initiative.
He says that 10 or 15 years ago, the Asian dollar bond market was dominated by Indonesia and Philippines bond issuers and to an extent Korea.
These countries have deleveraged significantly in terms of corporate debt to GDP ratios. Thailand has a very strong current account surplus, the Philippines strong and significant remittances from overseas workers, while some previously quite weak banking systems such as Korea’s have strongly recapitalised supported by very high domestic savings rates.
But the Belt and Road initiative looks set to become a significant influence on the market in several important ways.
“If you think about the big picture, on one hand, China has a lot of domestic savings on the other hand, the Chinese authorities still impose quite a lot of capital controls. They may not want a massive for capital outflows out of the country.
“The Chinese authorities are still encouraging Chinese companies, essentially, state-owned enterprises to acquire overseas assets or make loans to the Belt and Road initiative but if they cannot move their money from China to overseas, then they still need to issue dollar bonds. That is a factor in the recycling of the US dollar market. The Chinese government is committed to the Belt and Road initiative so the Chinese companies will still need to issue US dollar bonds in the medium to long run.”
In addition, the influence of the Belt and Road initiative combines with a development that may be less welcome in China – the movement of manufacturing jobs to cheaper centres and trade war tensions with the US that may see some production move to markets at less risk from US tariffs.
Thus these frontier markets may fund industrial expansion with dollar bonds.
“We expect more dollar bonds to come from some Frontier Markets. From Vietnam, but also from some very exotic markets such as Mongolia and even Papua New Guinea.”
He says the group may also include India, Thailand and Malaysia.
More generally Hu says that standards have risen dramatically meeting international standards in terms of issuance, market trading practices and covenants, with at least one of the big three international ratings agencies regularly involved. This has dramatically improved information flows.