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    Asia Bond Monitor: November 2016
    Asia Bond Monitor: November 2016
    Asia Bond Monitor: November 2016
    Ebook276 pages2 hours

    Asia Bond Monitor: November 2016

    By Asian Development Bank

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    About this ebook

    This publication reviews recent developments in East Asian local currency bond markets along with the outlook, risks, and policy options. It covers the 10 members of the Association of Southeast Asian Nations and the People's Republic of China; Hong Kong, China; and the Republic of Korea.
    LanguageEnglish
    PublisherAsian Development Bank
    Release dateNov 1, 2016
    ISBN9789292576523
    Asia Bond Monitor: November 2016

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      Asia Bond Monitor - Asian Development Bank

      Emerging East Asian Local Currency Bond Markets: A Regional Update

      Highlights

      Bond Market Outlook

      Local currency (LCY) government bond yields in advanced economies and emerging East Asia climbed between 31 October and 18 November due to increased concerns over the direction of the United States (US) economy.¹ With the recently concluded US election, markets outside of the US experienced rising uncertainty and increased risk aversion as investors struggled to discern the future direction of the incoming US administration’s economic policy. The US economy has also strengthened, increasing the likelihood that the Federal Reserve will raise the policy rate in December.

      Nearly all markets in emerging East Asia saw an uptick in 2-year and 10-year LCY government bond yields between 31 October and 18 November. The only exception was the People’s Republic of China’s (PRC) 2-year tenor which was unchanged.

      Given rising uncertainty, most central banks in emerging East Asia maintained their existing monetary policies in order to wait for greater clarity regarding US economic policy and its potential impacts on global financial markets.

      Currencies in all emerging East Asian markets fell against the US dollar between 31 October and 18 November. Regional currencies depreciated mainly on rising US yields and declining equity markets across the region. Almost all emerging East Asian equity markets declined except for those in the PRC and Singapore. Credit default swap spreads rose in all regional markets except in Thailand during the review period.

      Risks to emerging East Asia’s LCY bond market include (i) the prospective interest rate hike by the Federal Reserve; (ii) uncertainty over the direction of US economic policy; (iii) a hard Brexit, which would have serious repercussions for financial markets in emerging East Asia; (iv) the possibility of generalized global risk aversion toward emerging markets; and (v) the rise of protectionism and economic nationalism.

      This issue of the Asia Bond Monitor includes a special discussion box on the possible effects on the region of a Federal Reserve rate hike. (Please see The Potential Impact of a United States Interest Rate Hike on Emerging Asia.)

      Local Currency Bond Market Growth in Emerging East Asia

      Emerging East Asia’s LCY bond market reached a size of USD10,435 billion at the end of September. Growth in the third quarter (Q3) of 2016 moderated to 3.3% quarter-on-quarter (q-o-q) and 19.2% year-on-year (y-o-y) from 5.9% q-o-q and 21.7% y-o-y in the second quarter (Q2) of 2016.

      Indonesia was home to the fastest-growing bond market on both a q-o-q and y-o-y basis. In terms of absolute size, the largest markets were in the PRC and the Republic of Korea. These two markets together accounted for 86.9% of the region’s total bond stock at the end of September.

      Growth in Q3 2016 was largely driven by government bonds, which rose 4.8% q-o-q and 26.9% y-o-y. Corporate bonds grew at a slower pace of 0.9% q-o-q and 7.8% y-o-y.

      As a share of regional gross domestic product (GDP), the size of emerging East Asia’s LCY bond market rose to 69.9% in Q3 2016 from 68.2% in the previous quarter. The expansion was largely driven by government bonds, whose share of GDP rose by more than 1 percentage point to 44.6% in Q3 2016. On the other hand, the share of corporate bonds to GDP was broadly unchanged. Leading the region in terms of bond market size as a share of GDP were the Republic of Korea and Malaysia at 136.3% and 96.9%, respectively.

      Issuance of LCY bonds in emerging East Asia reached USD1,167 billion in Q3 2016, down 12.0% q-o-q but up 7.0% y-o-y. The q-o-q contraction stemmed from lower LCY bond sales in the PRC and the Republic of Korea.

      Structural Developments in Local Currency Bond Markets

      Foreign investor holdings of emerging East Asia’s LCY government bonds continued to rise amid a global low interest rate environment and after the US held off raising interest rates. Nonresidents increased their holdings of Indonesian, Malaysian, and Thai government bonds at the end of September. However, foreign outflows from these markets were observed in November amid global volatility in the aftermath of the US presidential election.

      Consistent with the foreign holdings data, foreign capital flows into emerging East Asia’s LCY bond market were positive in Q3 2016, albeit lower than in the previous quarter. The only market in the region that posted net capital outflows during the quarter was the Republic of Korea. However, some degree of reversal is expected given current market conditions that include investors shifting to safe-haven assets.

      Local Currency Bond Yields

      Emerging East Asian bond yields rose for nearly all markets and for most tenors between 31 October and 18 November amid uncertainty over future US economic policy and the likelihood of a Federal Reserve rate hike in December.

      Most emerging East Asian bond markets experienced a widening spread between the 2-year and 10-year yields between 31 October and 18 November, leading to steepening yield curves across the region. The only exceptions to this trend were in the bond markets of Indonesia, Malaysia, and Viet Nam.

      AsianBondsOnline Annual Bond Market Liquidity Survey

      Overall liquidity conditions for emerging East Asia’s LCY bond market have improved in 2016, according to the results of the most recent AsianBondsOnline bond market liquidity survey, which was conducted from late September through early October. The region’s average bid–ask spread for on-the-run government bonds narrowed to 3.8 bps in 2016 from 5.4 bps in 2015. Bid-ask spreads narrowed in all of the region’s government bond markets except for the Philippines, Singapore, and Thailand.

      The average transaction size for on-the-run government bonds climbed to USD5.2 million in 2016 from USD3.5 million in 2015, indicating an ability to transact larger volume trades.

      A widening of bid–ask spreads was observed in 2016 for corporate bond markets in the PRC, the Philippines, Singapore, and Thailand. Bid–ask spreads for corporate bonds fell in Hong Kong, China; and were broadly unchanged in Indonesia, the Republic of Korea, and Malaysia.

      Theme Chapter: Infrastructure Bond Market Developments in Asia—Challenges and Solutions

      We attempt to identify the determinants of infrastructure bond market development in Asia and to evaluate the impact of the Project Bond Initiative (PBI) on the development of infrastructure bond markets in Europe, with the objective of deriving policy implications for Asia.²

      The empirical results show that an economy’s size is positively associated with infrastructure bond market development. In addition, bond market standardization and harmonization through the Association of Southeast Asian Nations Plus Three (ASEAN+3) Bond Market Forum can facilitate the integration of individual Asian bond markets to help them obtain the minimum efficient scale needed to enhance liquidity and depth through an integrated regional bond market.³

      The empirical results also show that the PBI has contributed significantly to infrastructure bond market development in Europe. Considering the positive impacts of the PBI in Europe and the relatively lower credit ratings of infrastructure bonds in Asia, ASEAN+3 economies should take policy measures to facilitate the issuance of infrastructure bonds and strengthen the role of the Credit Guarantee and Investment Facility in providing guarantees for infrastructure bonds.

      Asia’s infrastructure bond markets are still at a nascent stage of development, especially when the amount of issuance is compared with needed investment levels. At the same time, meaningful progress has been achieved in facilitating an environment conducive for the issuance of infrastructure bonds. ASEAN+3 has demonstrated its commitment to developing infrastructure bond markets and the regional Credit Guarantee Investment Facility is now providing guarantees for infrastructure bonds. The time is opportune for ASEAN+3 to strengthen regional initiatives to promote infrastructure bond market development across Asia.

      Introduction: Bond Yields Rise Amid Uncertainties on United States Economic Policy

      Bond yields trended upward in advanced economies and in emerging East Asia between 31 October and 18 November (Table A; Figures A1, A2).⁴ Global bond yields have sharply risen since the conclusion of the United States (US) presidential election in reaction to uncertainty over the direction of the US economy policy under a new administration. While markets expect that the incoming administration will boost economic growth, the impact on markets outside of the US is less certain.

      Table A: Changes in Global Financial Conditions

      ( ) = negative, – = not available, bps = basis points, FX = foreign exchange.

      Notes:

      1. Data reflect changes between 31 October and 18 November 2016.

      2. A positive (negative) value for the FX rate indicates the appreciation (depreciation) of the local currency against the United States dollar.

      Sources: AsianBondsOnline, Bloomberg LP, and Institute of International Finance.

      Figure A1: 10-Year Government Bond Yields

      (% per annum)

      UK = United Kingdom, US = United States.

      Note: Data as of 18 November 2016.

      Source: Bloomberg LP.

      Figure A2: 10-Year Government Bond Yields

      (% per annum)

      US = United States.

      Note: Data as of 18 November 2016.

      Source: Bloomberg LP.

      A solid consensus among market participants and observers that the US Federal Reserve is likely to raise rates in December has also placed upward pressure on yields. While the Federal Reserve held off raising the federal funds rate at its most recent meeting in November, subsequent testimony by Federal Reserve Chair Janet Yellen indicated that a hike could occur soon if the data suggest it. The Federal Reserve noted in its last meeting that while US employment levels were stable in October, job gains had been solid. Inflation has also picked up in the latter part of the year, although it is still below the Federal Reserve’s long-term target.

      While the Federal Reserve noted stable monthly job gains, the August and September increases in nonfarm payrolls of 176,000 and 191,000, respectively, were below June’s 271,000 and July’s 252,000. At the same time, the average monthly increase in nonfarm payrolls was 206,000 in the third quarter (Q3) of 2016, up from 146,000 per month in the second quarter. Increase in nonfarm payrolls in October came in at 161,000.

      Other economic data suggest that a December rate hike is likely. Gross domestic product growth in the US accelerated to an annualized rate of 2.9% in Q3 2016 from 1.4% in the previous quarter, buoyed by strong export growth.

      The monetary policies of other advanced economies paint a mixed picture. While markets have anticipated US policy tightening, the European Central Bank (ECB) is maintaining several of its policies. For example, the ECB kept policy rates unchanged and left intact its asset purchase program during its September and October meetings. The asset purchases are scheduled to end on March 2017 even though market participants prefer an extension of this program. Therefore, the ECB leaving its current plan unchanged was viewed as policy tightening. Inflation in the European Union also crept upward, with October inflation rising to 0.5% year-on-year (y-o-y) from 0.4% y-o-y in September.

      In contrast to the ECB and Federal Reserve, the Bank of Japan intensified its monetary easing in September by adopting a New Framework for Strengthening Monetary Easing, which involves yield curve control measures that target both short-term and long-term interest rates. The Bank of England eased monetary policy in August by cutting the bank rate by 25 basis points (bps) to 0.25% and adding an asset purchase program. In its September meeting, the Bank of England maintained its existing monetary policy.

      Nearly all markets in emerging East Asia saw an uptick in 2-year and 10-year local currency (LCY) government bond yields between 31 October and 18 November, driven by expectations of a Federal Reserve rate hike and market volatility following the conclusion of the US presidential election. Most of the region’s central banks have adopted a wait-and-see position given the looming rate hike in the US and other economic uncertainty. A notable exception was Bank Indonesia, which eased monetary policy by reducing its 7-day reverse repurchase rate by 25 bps in both September and October for a cumulative reduction of 50 bps since it began using this rate as a benchmark policy rate in August. In its November meeting, Bank Indonesia held steady its policy rate in response to global market volatility.

      The overall regional trend has been toward higher yields as LCY government bond yields rose in nearly all markets between 31 October and 18 November. The only exception was in the People’s Republic of China (PRC) where the yield for the 2-year bond was unchanged. The largest increases occurred in Malaysia, where the yield for 2-year bonds rose 92 bps and the yield for 10-year bonds climbed 80 bps. Indonesian bond yields also gained 72 bps and 59 bps for the 2-year and 10-year maturities, respectively. Indonesia and Malaysia were most affected as their bond markets are vulnerable to foreign capital outflows due to large shares of foreign investor holdings that exceeded 35% in both markets at the end of September.

      Currencies in all emerging East Asian markets fell against the US dollar between 31 October and 18 November. The decline in the region’s currencies was mostly due to the rise in US yields and declines in the region’s equity markets. Outflows are expected from the region’s bond markets as the rise in US yields makes US assets more attractive. The steepest currency declines were in Malaysia (–5.3%) and the Republic of Korea (–3.4%).

      Equity markets throughout the region stumbled in the wake of the US elections, except in the PRC and Singapore. The declines came despite gains

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