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June 2024
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Reasonable growth, moderating inflation and lower policy rates provide a positive backdrop for the fixed income asset class. In China, we are encouraged by the latest measure by the government to address the property sector.
This month, we move our Overweight recommendation of US Treasuries (USTs) to Neutral. This is consistent with a soft-landing view which removes the need for a recession hedge. While we still expect lower rates over the next 12 months, we position this via our Overweight recommendation in Developed Markets (DM) Investment Grade (IG) bonds. We retain our Overweight recommendations in Emerging Markets (EM) High Yield (HY) bonds, stay Neutral in DM HY and remain Underweight EM IG on valuation grounds.
Developed Markets
The fundamental and technical backdrop remains supportive of the current tight spread environment. Even in a “higher for longer” rates environment, refinancing risks remain low.
However, as more debt gets refinanced into higher rates and assuming no equivalent growth in EBITDA, interest coverage will eventually decline but the process will take years to materialise. Meanwhile, in the last three years, US IG have seen ratings migration skewed towards upgrades, reversing the waves of downgrades during the Covid-19 period. The quality breakdown is converging towards a higher portion in the “A”-rated bucket, with a declining proportion in the “BBB”-rated segment.
Meanwhile, issuers have been actively issuing year-to-date. Given the inflationary uncertainty and impending US elections, issuance may moderate in 2H2024. In HY, the default picture appears rather benign. The US HY distress ratio – a key indicator of the default ratio – is currently about 7% which is lower than the post-global financial crisis average of 13.2%. The media & telecommunication sectors currently have the highest percentage of distressed issuers.
Emerging markets
Spreads in EM have tightened consistently on stable fundamentals, soft landing optimism and easing financing condition. We maintain an Overweight on EM HY – spreads could further compress against EM IG given the improving distressed ratio in the HY universe. We remain Underweight on EM IG as we expect it to underperform on a relative basis given the lack of spread over DM IG.
Asia
In Asia, we continue to prefer HY over IG and maintain an Underweight in Asia IG and Overweight in Asia HY on valuation grounds. Credit fundamentals for most issuers remain stable and market technicals remain supportive.
The relative outperformance of China HY continued in May, supported by the recent strengthening measures for the property sector. Overall, we see the policy pivot to destocking as directionally positive. We believe the recent slate of measures are aimed at limiting further downside risks, rather than to stimulate a major turnaround for the property sector. Having said that, effective implementation could be challenging. We expect more measures to be released if sales remain sluggish and price expectations do not stabilise, especially in the run-up to the Third Plenum in July. Within the bond universe, we expect still surviving developers with quality land banks to benefit more from the headlines. As for defaulted names, we think they are unlikely to benefit much from the recent measures.
Indian credit has had a strong year. We continue to favour Indian credit across a range of sectors, including renewable energy and airports. We will monitor the new government’s policies in relation to these and other sectors.
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