Asian Emerging Market USD credit: Liquidity vs Fundamentals
By Marcus Weston, Portfolio Manager, JK Capital Management Ltd. a La Française group-member company
In the second week of March this year, global credit markets went into a tailspin. As the reality of the COVID pandemic began to dawn on global investors culminating in the ominous headline that even actor Tom Hanks had contracted the virus, bond markets panicked sending the US investment grade bond market into a 6.3% drop in 10 days (as per the Bloomberg Barclays Indices), the sharpest price drop since the 2008 financial crisis. After tinkering with monetary and fiscal policy in the preceding weeks, the US acted finally decisively on March 15th with Fed chairman Powell announcing a 100bps cut in interest rates to zero and the launch of a new aggressive QE program with reportedly ‘no limit’ on its scale. With subsequent announcements of further large scale fiscal and monetary programs across the developed world, the global bond market effectively set its floor.
For Asia credit investors the critical question was to what extent such stimulus might translate into demand for Emerging Markets (EM) bonds? Although the Fed’s aggressive bond buying program would not be extended for foreign issuers, previous rounds of QE had clearly shown such liquidity injections often translate into a melt up scenario for EM credit. Complicating the matter in 2020, however, was that the cause of the market crisis, i.e. the COVID outbreak was still highly unpredictable. As the disease ravaged developed market economies in March and April there remained much uncertainty to what extent the outbreak would affect poorer countries with weaker healthcare systems and more fragile external liability positions. Indeed these fears were realized in April and May as, despite a stabilization of the virus in many developed countries, the outbreak significantly accelerated in EM with Brazil, Russia and India, in particular, showing an alarming growth in infections. Leading data indicators also pointed to a severe impact on EM domestic economies with India for example posting an astonishing service PMI number of just 2 for April.
In such an environment, one could naturally expect a bifurcation of the market with wealthy developed countries, bolstered by huge monetary stimulus significantly outperforming their poorer EM cousins with further saber rattling from the US over China’s alleged blame for the virus further dampening EM sentiment. In reality however, EM markets did the opposite with the Bloomberg Barclays dollar EM bond index gaining 7.3% over April-May compared to a 6.9% gain in US corporate bonds. Within Asia, EM sensitive countries like Indonesia and India outperformed to an even greater extent with bonds issued by the ravaged Indian economy, gaining as much as 10.9% over the same two month period. Of course not all EM performance can be celebrated with Argentina defaulting in May while closer to Asia, low rated Sri Lankan bonds massively underperformed the rebound. However a key lesson remains the continued trumping of liquidity over fundamentals and just as US stock markets have rallied to record highs during a period of economic and civil unrest so Asian bond investors should be careful not to ignore the stimulus train which has once again superseded economic reality.
Informative Document for non-professional investors as defined by MIFID II. The information contained herein is issued by JK Capital Management Limited. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. The information and material provided herein do not in any case represent advice, an offer, a solicitation or a recommendation to invest in specific investments. To the best of its knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. JK Capital Management Ltd. is a limited company regulated by the Securities and Futures Commission of Hong Kong, with its registered office at Rm 1101 Chinachem Tower, 34-37 Connaught Road Central, Hong Kong.