t concerns hasten from emerging headwinds for asian · pdf fileedwin chan, ubs outlook: 1 ......

Analysts

Edwin Chan, UBSOutlook: 1

We are looking for credit spread compression to offset the rise in US treasuries yields as global economies pick up, which should be reinforcing for Asia.

Agnes Wong, Pradeep Mohinani, William Mak and Annisa Lee, NomuraOutlook: -1

We kicked off the second half of 2013 with a bearish view of Asian credit markets for reasons that include: (i) a deteriorating sover-eign and corporate credit outlook with poor technicals dominated by

Headwinds for Asian credit

Tapering concerns hasTen ouTflows from emerging markeTs

International fixed-income investors nominated above 440 valued sellside individuals this year, in the 13th annual Asian G3 Bond Benchmark Review. We asked these top research, sales and trading individuals in Asian G3 bonds about their outlook for the year ahead – on a scale of -2 (most negative) to +2 (most positive) and the reasons behind their rating

– By asseT Benchmark research

over money returning into the asset as long as default rates remain man-ageable.

Across the region, the Southeast Asia trade into North Asia has played its course. Instead we remain vigilant of China’s growth with 7.5% looking less sustainable for 2014, and take into account (i) the downside risks in the China property sector due to higher leverage and a more aggres-sive land acquisition strategy, and (ii) a clean-up of the banking sector still

fund outflows which have persisted through the summer and (ii) a heavy issuance leading into the sell-off, fur-ther weighing on performance.

Fast forwarding to today, a num-ber of new themes have developed, forcing us to take a less bearish view on spread outlook but knowing well that Asian fundamentals still have more downside. Valuations have become more attractive to the point of reflecting a weaker outlook, while outflows can be cushioned by cross-

40 October 2013

Edwin ChanUBS

Agnes Wong Nomura

Pradeep Mohinani Nomura

William MakNomura

Annisa LeeNomura

Keith Chan HSBC

Desmond LeeMorgan Stanley

Ray HeungBNP Parbias

No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research Limited

October 2013 41

to be undertaken.Korea has been a favourite

among investors due to the strength of its external balance sheet, however, domestic lever-age of corporates and consumers has only worsened which could finally result in wider spreads. On the other hand, valuations on India and Indonesia look attrac-tive post the sell-off, however, our conviction on going long is low. This is supported by an overvalued rupiah and a weak external balance sheet in the case of Indonesia, while the loss in domestic growth momentum in India has the ability to stem any meaningful rally in spreads. Overall, we would argue that our slightly bearish view will be supported on the basis of higher absolute US treasuries yields which will likely contribute to investment-grade (IG) spreads holding up while high yields (HY) are expected to underperform due to the deteriorating outlook.

Desmond Lee, Morgan StanleyOutlook: -1

The regional economies are slow-ing at a time when inter-est rates are rising (both US dollar and domestic rates), which will pressure credit metrics and drive up default rates. Because of their weakened liquid-ity and tight net inter-est margins, Asian banks will become more selec-tive in who they lend to and how much they will charge, which will increase refinancing risks for the more marginal corporates. Bond supply pressures will increase as corporates seek alternative sources of funding (outside banks) while the fund inflow envi-ronment for Asia appears more challenged in the near term.

Feng Zhiwei, Standard CharteredOutlook: 0

Investor sentiment is easily affected by technical and fundamental factors such as US treasuries volatility, fund flow, supply pipeline, as well as the eco-nomic prospects of major Asian coun-

tries and elsewhere in the emerg-ing markets (EM) and developed markets (DM). For Chinese HY property, the largest component of Asian HY bonds, I think policy risk has started to grow, albeit not imminent. That said, most HY developers have maintained strong liquidity to weather market changes. While product demand and prices for the industrial-sector companies may have bottomed out, any recovery is likely to be slow or gradual. Taking all this into consideration, Asian HY bonds are close to their fair values, yielding an average 8.8% currently. Despite the likely volatility, I think the HY names still offer value with both carry and upside potential although credit selection/differen-tiation remain key. A volatile mar-ket provides opportunity for port-folio repositioning/rebalancing to maximize future returns.

Ray Heung, BNP ParibasOutlook: -1

The tapering concerns in May this year awoke investors from the low-vola-tility in the past few years. The outflow from less convinced investors continues

Analysts’ outlook for the bond markets

Rank Name Bank 1 Edwin Chan UBS b 2 Agnes Wong Nomura 3 Pradeep Mohinani Nomura b 4 William Mak Nomura 5 Annisa Lee Nomura b 6 Keith Chan HSBC 7 Desmond Lee Morgan Stanley 8 Soo Chong Lim J.P. Morgan 9 Feng Zhiwei Standard Chartered 10 Ray Heung BNP Paribas

Top analysts

b Top ranked for the past three consecutive years or longer

Top ten banks with most nominated individuals


expected to tighten in many economies. Combined with a headwind from slow-er growth and in some cases from cur-rency volatility, corporate fundamentals are likely to deteriorate. Valuations, while more attractive than earlier this year, haven’t dislocated to levels than can attract incremental investors. As a result, we retain a slight negative bias.

Michele Barlow, Bank of America Merrill LynchOutlook: -1

Asian credit markets will face head-winds over the next year as higher US and domestic rates, tighter liquidity con-ditions, and slowing economic growth – coupled with higher corporate leverage and a weakening technical environment

– put pressure on funding costs leading to higher defaults.

Kaushik Rudra, Standard CharteredOutlook: -1

I am negative on the Asian G3 bond markets over the next 12 months. While spreads on Asian G3 bonds are starting to look attractive, particularly relative to US credit markets, I expect the sector to generate modest nega-tive returns over this period. A combination of rising US treasur-ies yields, challenging economic fundamentals and worsening cred-it metrics will likely keep fund flows under pressure. Although I do not expect institutional funds to withdraw from this space, rel-atively poor sector performance along with the above-mentioned negative factors will likely limit potential inflows to this segment

of the market. Finally, I continue to see a relatively healthy primary pipeline; while most of this is opportunistic in nature, I expect any spread tightening or period of relative stability to be met by issuance – this will limit the potential for any spread performance.

Salespeople

Bryan Tan, BNP ParibasOutlook: -1

My personal view is that in the next 12 months, Asian credit—and indeed EM credit as an asset class—could be in for rocky ride. Following the QE-addicted world of 2012 (that glorious year where inflows, massively

to pull money out of EM, Asia included, and therefore we are still likely to see some more drawdowns from Asia. Some of the countries in Asia are more exposed as they have been reliant on inflows. We saw India and Indonesia already, we may see Malaysia and Thailand to be the next in line. So we expect the first half of next year to remain volatile.

Economists/Strategists

Viktor Hjort, Morgan StanleyOutlook: -1

After three years of rising lever-age, the Asian credit cycle is likely turning adverse. Corporate Asia now has the world’s most lever-aged balance sheets – a challenge as funding costs are rising, driven by higher real rates, China bank regu-lation and tighter banking system liquidity across the region. This time Asia’s banks are less likely to provide all liquidity that is needed. Banks are already tightening lending standards and our bank team expects deceler-ating credit growth, both of which point towards higher bond supply risk and higher default and non-performing loan rates.

Krishna Hegde, Barclays CapitalOutlook: -1

Ripple effects of monetary policy normalization in the US are likely to be a key headwind for the Asian credit markets over the next year. We expect demand for credit to be affected by crossover investors pulling back. At the same time, financing conditions are

42 October 2013

Economists and credit strategists’ outlook for the bond markets

Rank Name Bank 1 Viktor Hjort Morgan Stanley b 2 Krishna Hegde Barclays Capital 3 Johanna Chua Citi b 4 Avanti Save Barclays Capital 5 Michele Barlow Bank of America Merrill Lynch 6 Frederic Neumann HSBC b 7 Kaushik Rudra Standard Chartered b 8 Wang Tao UBS 9 Prakriti Sofat Barclays Capital = Ting Lu Bank of America Merrill Lynch 10 Dilip Shahani HSBC

Top economists and credit strategists

Viktor Hjort Morgan Stanley

Krishna HegdeBarclays Capital

Johanna ChuaCiti

Michele BarlowBoAML

Kaushik RudraStandard Chartered

Prakriti Sofat Barclays Capital


October 2013 43

oversubscribed orderbooks, new issue performance and happy times were par for the course), the mere mention of tapering this year sent centipedes down the pants of EM investors globally who dreaded having to go cold turkey. Funny thing is: wasn’t tapering supposed to be a sign that the US economy was recovering? Perhaps spreads are correcting now from last year’s technical rally to reflect proper value. Are we getting a dose of mean reversion, where weak credits trade like weak credits? Regardless, with tapering largely expected to commence soon this year, we will likely get volatility in core rates, and this would spell trouble for an EM credit landscape that is so sensitive to US treasuries yields and the FX market. With that, odds are we get a continuation of outflows from EM bond funds in the near term.

Add to the cauldron a new issue pipeline simply bursting at the seams with a veritable buffet of issu-ers: from established blue-chips eyeing jumbo three-tranchers to idiosyncratic first-timers hawking untested methods of credit enhancement. And on top of it all, looming over us ominously like a dark raincloud, is the element of geopolitical risk with the situation in Syria, ever-ongoing tension on the Korean peninsula, and numerous other combustible situations that exist in our international reality.

Indeed, the focus on deteriorating sovereign fundamentals should contin-ue, with India and Indonesia currently in the spotlight, and investors keeping an eye on Malaysia and Thailand as well. And if those are under scrutiny,

then what of higher beta peripheral economies like Sri Lanka, Vietnam and Mongolia? While there undoubtedly will be pockets of strength, my sense is that here in Asia – where corporate credit is so clearly sectored by country borders – sovereign weakness could very quickly translate to declining health in the broader credit market.

Chong Hui Chin, Bank of America Merrill LynchOutlook: -1

With hindsight, none of us should have been surprised by the immense EM stock and bond outflows that we have been experiencing over the past three months. Rising interest rate has always been an EM pain trade, or did we believe

that deeper financial markets and better credibility of EM economic policies had made us less vulnerable to rise in yields in DMs? I believe in the former. Rise in US yields for the last few months has already exposed heightened financial vulnerability in major Asian markets, such as India, China, Indonesia and Malaysia. Obviously, internal macroeconomic factors differ from countries but in some, the probability of EM banking crises is rising. For the year ahead, Asian G3 credits will experience more volatility and for the lower rated credits illiquidity as investors become credit-selective and flows from EM into DM are likely to persist.

Leonora Lok, CitiOutlook: -1

I think Asian G3 bond markets will have a challenging year ahead as investors navigate bear markets in

fixed income, against a macro backdrop where there is a general expectation of slowdown in growth in the EM countries in Asia, progressive tapering from the Fed into mid year 2014 and unresolved structural issues in Europe. Although some of these factors have already been priced into current markets, an important driver which is hard to predict (and yet could trigger further underperformance) is the fund flows for 2014 – whether funds will be moving from credit to equity and whether we will see a switch from EM into DM.

Tommy Leung, UBSOutlook: -1

Two factors have supported the rapid growth of the Asian credit mar-

Salespeople’s outlook for the bond markets

Rank Name Bank 1 Anthony Neo Citi 2 Bryan Tan BNP Paribas 3 Chong Hui Chin Bank of America Merrill Lynch

4 Barry Tan Standard Chartered b 5 Leonora Lok Citi 6 Sandra Agdamag Barclays Capital 7 Jamie Fernando Royal Bank of Scotland 8 Tommy Leung UBS 9 Stephen Mak Barclays Capital b 10 Christina Park Morgan Stanley

Top salespeople

Bryan Tan BNP Paribas

Chong Hui Chin BoAML

Barry TanStandard Chartered

Leonora Lok Citi

Tommy LeungUBS


44 October 2013

ket over the past couple of years: the robust economic growth relative to the developed world, and the ongo-ing search for yields in a low inter-est rate environment. However, these two drivers have started to lose steam since the end of the first half of 2013. Growth in Asia has slowed while yields on US treasuries have surged in anticipation of the US Fed’s taper-ing of its quantitative easing. These recent changes have resulted in nega-tive returns and greater market vola-tility for Asian credit.

Looking ahead, the soften-ing growth outlook, combined with heightened rate volatility will contin-ue to weigh on the market. The technical backdrop will weaken as marginal inflows slow, while the supply pipeline remains heavy. Even though I don’t foresee any major credit events, the upside for credit is likely to be capped, particularly for IG bonds.

Traders

Dean Wang, Morgan StanleyOutlook: 1

The outlook on Asia credit next year remains uncertain. In particular, I expect considerable challenges over the next six to nine months in our universe. The ongoing deleveraging in Asia banks and the necessary rational-ization of Asia’s economic mod-els should cap upsides in our market. This results in persistent supply-led pressure, especially in the BBB segment. Issuers will be subject to the more stringent

credit assessment in the public bond markets. Thus, there is a constant risk of markets re-pricing wider. The Chinese quasi-sovereign precedents should remind investors of the peril ahead. In addition, I see a more bipo-lar IG universe and a more idiosyn-cratic HY sector.

No despair though. These are signs of a growing market. We have already seen more regional participa-tion in Asia credits over the past few years. Asia fixed income will continue to play an important role in asset allocation, even in an rising inter-est rate environment. Wider spreads and a broadening credit spectrum

offer unprecedented opportunities for investment professionals to dif-ferentiate themselves via the arduous credit-selection process.

Conor Yuan, NomuraOutlook: -1

I think credit as an asset class is no longer favoured by institutional investors (pensions funds, endow-ments, etc) and individuals (private banking clients) who can look at various products. As such, the inflow story which has been in place since 2009 is in danger. On top of that, I think EM underperforming DM will be one of the major themes in next

few years, with Asia (especially Southeast Asia) likely to experi-ence periodic shocks as money continues to return to the US and Europe.

Last but not least, supply in Asia credit will likely remain heavy as a lot of the post-crisis bond issuance will mature next year. Despite such negative fac-tors, we have to appreciate the growth of the Asian real-money clients base—insurers, sovereign wealth funds (SWFs), commer-cial banks and domestic fund managers. This is evidenced by the growing percentage of Regs-only deals as Asian local support has played a much more impor-tant role than two years ago.

Paul Marshall, Barclays CapitalOutlook: -1

The Asian credit market is going to remain challenging for both traders and investors in the coming months. Attempts by

Dean WangMorgan Stanley

Pracheesh MishraCiti

Conor YuanNomura

Paul Marshall Barclays Capital

Traders’ outlook for the bond markets

Rank Name Bank 1 Dean Wang Morgan Stanley b 2 Pracheesh Mishra Citi 3 Conor Yuan Nomura 4 Amanda Wu Goldman Sachs 5 Paul Marshall Barclays Capital = Archie Sy Royal Bank of Scotland b 6 Anand Subramanian Deutsche Bank 7 Upwan Ratti Crédit Agricole 8 John Chua Morgan Stanley 9 Matt Greenberg J.P. Morgan 10 Kevin Aepli UBS b = James Magsuci Standard Chartered

Top traders


October 2013 45

Archie Sy Royal Bank of Scotland

the US Federal Reserve to withdraw accommodation will have an inevi-table knock-on effect on EMs and the path to a more “normal” rates environment will not be smooth. I can foresee a situation in which credit markets overshoot in both directions especially in view of reduced risk tol-erance on the part of the sellside, and investors adapting to reflect current trading conditions.

Anand Subramanian, Deutsche BankOutlook: 1

I am positive (+1) on credit spreads in 2014. With the Fed tapering and interest rates rising globally, we are seeing an unwind of cheap liquid-ity provided by central banks which fuelled a great bull run for credit in the last three to four years. There is going to be more credit differen-tiation as fundamentals play a greater role compared to technicals. Hence, credit selection will be key and invest-ment will be based on proper credit analysis – as compared to merely deploying cash due to inflows. The EM asset class is here to stay, as you do get a sufficient premium over DM for similar credits. A lot of global money managers and hedge funds have set up offices in Asia or increased resources in the region to focus on Asian G3 bonds.

John Chua, Morgan StanleyOutlook: 1

At current valuations, the bias would likely be more positive (+1). Massive repricing in credit across the board on the back of the rates move, a slowing of growth etc actually has made EM in general revert back to very attractive levels – levels at which one would be more comfortable to own risk. I believe we will still see a lot of volatility on the rates and FX front, which naturally correlates strongly with our segment. I don’t see the market settling until at least post the September Federal Open Market Committee (FOMC), US data etc.

A number of things to note, even with my slightly more constructive view:

(i) Supply having to come at substan-tial discounts to the curve (what accounts

are demanding for every new deal in the market);

(ii) Despite the outflows of funds that are still pretty consistent, we have wit-nessed pockets of constructive buying that have been encouraging;

(iii) Lastly, something to think about: Brazil 23s were at 2.97% in May, and at 4.68% as of September.

James Magsuci, Standard CharteredOutlook: -1

The rising US treasuries yields will remain as the primary driver of EM credit markets in the medium term, and with ten-year US treasuries expected to rise further (from the current 3%), EMs will continue to be under pressure as we see global re-allocation of assets. Asia came from a level of tight spreads and from a period where the US/Europe outlook was bleak. Now we are seeing the reversal of this as the US/Europe go through a period of recovery – therefore attracting money back into DM and away from EM.

Anand Subramanian Deutsche Bank

Upwan RattiCrédit Agricole

John Chua Morgan Stanley

Market outlook for the year ahead from the top 10 individuals


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