Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause
If we had to make a base observation for Asia credit markets over 2018, it was certainly caught “wrong-footed” like most of its other risky asset counterparts. The combination of a more hawkish Fed in 2018, global quantitative tightening, late-cycle economic conditions, volatility and a strong USD have all served to impact almost all the asset classes negatively. According to some asset allocators, the only asset class which returned positive in 2018 was cash, every other traditional asset class saw losses.
USD direction will further dictate the impact on overall Asian risk, in our view, with many undervalued Asian currencies following their sharp declines in 2018. One of our scenarios includes a range-bound USD in 1H19, followed by a possible reversal in 2H19 on any dovish Fed policy/US economic weakness. In this case, it has the potential to attract incremental portfolio inflows back into Asian risk. We expect a slightly tighter bias in monetary policy in most Asia ex-Japan nations which is supportive for their respective currencies.
In 2019, risk-reward dynamics have improved particularly for Asian investment grade (“IG”) where we see more limited MTM pressure. We expect a more defensive market at least in 1H19 which supports our heavier IG bias. We suspect larger investors would continue to reallocate depending on the outcomes of the China-US trade dispute and their view on US risk (arguably near its last late-cycle expansion legs). We continue to be extremely selective in Asian high yield (“HY”) which have been impacted by idiosyncratic situations including credit deterioration and rising defaults. Exogenous factors such as the potential for “fallen angel” risk (i.e. a migration from issuers on the cusp of IG, “BBB-” into HY) as well as net portfolio outflows from HY, EM and leveraged loan funds are ongoing concerns. Despite cheaper valuations in Asian HY, we still see skewed risk-reward (with larger potential risks).
In the US, our base case expects the Fed to hike 1-2 times (quarter point each) for 2019, premised on still below-trend inflation and external factors. We think it is near the tail-end of its current tightening cycle, but we would continue to monitor the US supply-side (labour markets, employment gaps, prices) for further clues. A sustained upshot to the previous factors may have the potential to prolong the Fed’s tightening cycle.
On China’s side, we have seen a critical reversal in policy towards selective expansion/accommodation again as economic reforms instituted 3 years ago have been reprioritized. China’s difficult task to balance growth targets and restructure its economy is a perennial issue. We would also expect defaults to remain elevated domestically/internationally as a new paradigm of credit investing takes root in China.
Finally, we would like to wish our readers luck in investing and trading in the year ahead.