The Asian Development Bank’s Yield Chase Chastening

The Asian Development Bank’s November local bond monitor covering the third quarter in nine East Asian government and corporate markets showed “strong” 11.5% annualized growth to $11.5 trillion in total, but also pointed to higher yields and foreign capital outflows at the end of the period amid lingering qualitative and quantitative liquidity concerns. Advanced economy central bank balance sheet normalization and increased global GDP expansion have not affected financial market stability, but “potential risks” encompass monetary policy and structural features, including the lack of hedging instruments. China continues to dominate regional markets with a two-thirds share, and bond size to GDP is now 70% with Korea and Malaysia leading the pack under that measure. October international selloffs were pronounced in Indonesia and Thailand, as East Asia still struggles to diversify the investor base, according to the report. A periodic liquidity survey found an even split between countries improving and stagnating with Hong Kong, Vietnam and Singapore in the former and the Philippines in the latter. The ADB warned that dealing amounts and spreads suggest longer-term bottlenecks which could aggravate overseas sentiment turn as the current return “chase” abates.

Vietnam was the exception as 2 and 10-year government bond yields fell after a central bank rate cut. In China deleveraging raised costs beyond developing Asia’s better growth outlook, with the ADB prediction at 6% this year on 2.5% consumer inflation. The marginal uptick has not punctured the simultaneous stock market rally, with emerging Asia up 35% on the MSCI index as world interest rates and volatility remain low on “solid” corporate earnings, particularly in the technology sector. Foreign ownership of local debt jumped to 40% in Indonesia after a sovereign rating upgrade, and most currencies depreciated slightly against the dollar outside a 1% Malaysian ringgit gain.

Domestic bond issuance rose 4% from the second quarter, and Korea solidified its number two position as the market approached $2 trillion. Malaysia and Thailand are next at $300 billion in size, with Islamic sukuk 60% of Malaysia’s total. Indonesia and the Philippines are in the respective $200 billion and $100 billion ranges, and Vietnam is the smallest at $50 billion with a negligible corporate segment, which is one-third overall activity on average. China, which just opened the government market, has the lowest non-resident share at 3% followed by Korea at 10%, where portfolio outflows accompanied military threats from the North. Chinese firms led in regional cross-border placements with $1.5 billion, while Malaysia’s Maybank and national mortgage company Cagemas had the biggest single transactions in Chinese Yuan and Singapore dollars. East Asia offerings in the dollar, euro and yen reached $250 billion through the third quarter, already 10% ahead of full year 2016, with China and Hong Kong sponsors accounting for 75% of volume.

Bond market-related policy and regulatory shifts were notable over the period, including repo launch in the Philippines; a cooperation pact between securities supervisors in China and Singapore; foreign company authorization for Thai baht-denominated issuance; and approval of a medium-term capital market development plan in Vietnam. They were incorporated into interviews with fixed income sales and research desks, asset managers and strategists, and official overseers across the nine economies to determine prevailing liquidity conditions. By turnover ratio only Thailand, Hong Kong and Indonesia were over 0.5 for the quarter as active markets, while bid-ask spreads reduced 5 basis points. Average government bond trade size decreased from a year ago to $5 million, with tightening most prominent in China and Korea, the largest markets, due to respective non-bank crackdown and geopolitical drags. Respondents also highlighted structural weaknesses in rank order, from the lack of derivatives and private institutional investors to onerous custody and settlement and tax treatment. Malaysia was singled out as scoring well overall but damaged by recent offshore currency hedging restrictions. Withholding tax is steepest in Indonesia and the Philippines at 15-20%, while Vietnam is in the earliest stage of derivatives development. On the corporate side, secondary markets do not exist in Philippines and Vietnam and liquidity is otherwise “subdued.” Transparency has improved with available and accurate pricing and financial data through dedicated platforms, but capital and access controls are uneven and may become choppier should bond performance sour in coming months and further compromise category outcomes, the survey implies.

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