The US Federal Reserve’s rate hiking cycle, the fastest in four decades, has transformed bond markets across the world. By raising rates by 525 basis points since March 2022, debt issuers are strategising their financing plans against a backdrop of much tighter monetary conditions. The result is a drought of USD-denominated bonds, with global bond issuance falling to a decade low in the first quarter of 20231.
There are signs however that the direction of US monetary policy could change, as markets focus on the increased probability of a recession in the world’s largest economy. Most notably, US treasuries are taking the lead by suggesting that a turn in the rate cycle is already priced in.
“We can say that longer-run US Treasury yields most likely peaked at the levels reached last October” said Steven Major, Global Head of Fixed Income Research, HSBC, who was speaking at the HSBC 7th Annual Asia Credit Conference.
Shortage of supply
In Asia, higher rates in the US have led to a sharp decline in international bonds – i.e., bonds issued outside the issuers home jurisdiction. In 2022, issuers in Asia raised USD 346 billion, down 44% from the record USD 610 billion in 20212. In the first half of 2023, regional issuance remained subdued.
An additional factor that has contributed to the reduced issuance is the withdrawal of Chinese property developers – a key segment that drove growth in the region’s high-yield market over the last decade.
Investors with a mandate to invest in Asia are looking ahead to the next generation of issuers that will revitalise issuance in the region. The new sectors will likely be ones that start off as high yield and gradually move towards investment grade. Companies on the electric vehicle value chain are a strong candidate but as of yet have not issued debt in Asia.
For investors that do not have a mandate to focus on Asia, such as private banking clients, the regional USD-denominated supply drought is an opportunity to look further afield for attractive investment opportunities.
Some investors are looking outside of the region to US investment grade, while others are considering developed markets in Asia, like Australia and Japan, and emerging markets like India, said Carman Lau, Head of Fixed Income, North Asia, HSBC Global Private Banking and Wealth.
“In Japan, investors can find relatively stable banks, and low volatility names that they are familiar with, while Australia is attractive from a valuation perspective,” she said. “Greater China clients are not very familiar with Indian credit, and we are providing more education of the market and highlight the opportunities, especially in renewable energy.”
Buoyant local currency markets
USD issuance is not the only story in Asia, as higher rates in international markets have added energy to the region’s local currency markets where in many cases funding levels remain relatively low. IDR issuance in Indonesia, MYR issuance in Malaysia, and THB in Thailand are all strong. So too is debt capital raising in CNH and HKD in Hong Kong.
Part of this is due to issuers looking onshore for rates lower than those available in the USD market. But there is a broader development at work, as the strong local currency issuance is a sign that the financial markets in these regional economies are now strong enough to support the fundraising needs of local companies.
Issuing debt in a local currency can make sense for a multinational organisation too – such as a company operating across the region, with cash flows and liabilities in multiple currencies. Large international insurers, for example, are a sector that is leveraging local currency markets, when it is appropriate for their capital structure.
From an investor perspective, the behaviour in local currency markets is different to USD debt markets, said Daniel Lam, Portfolio Manager, HSBC Global Asset Management. For a start, assets under management that are directed towards local currency markets tend to be sticky, as they are comprised of funds from local institutions, insurers, and corporates deploying their treasury account.
Mr. Lam also described the advantages of local currency private placements: “There is less liquidity in these bonds, but if an investor can hold it, there will be less trading and lower volatility. That’s why the performance is steady.”
Strength in private credit
Private credit is another area in Asia that has received a boost from the low levels of liquidity in the broader market. For investors, it provides opportunities offer to enter into transactions that deliver high returns.
That said, the rapid change in market conditions means that there can sometimes be a mismatch between the rate that borrowers think they can achieve and the rate at which investors are willing to lend. Also, deals need to be structured so make investors comfortable with the risk that are taking on, with adequate collateral a key part of how the deals are structured. But when deals do go ahead, both lender and borrower benefit.
“There is an opportunity for private credit funds to come, provide bridge financing, and get the business community through the high-rate environment over the coming 18 to 24 months,” said Bo Hu, Managing Director, Head of Private Credit, Asia-Pacific, HSBC.
An evolving region
The rapid pace of the Fed’s change in interest rates have changed the landscape of Asian credit. Some of these changes will reverse over time, when the USD bond market once again becomes more active. But some changes are likely more permanent, as issuers and investors now have greater experience in the wide range of Asia’s local currency markets. The end result will be a more diverse market that better meets the needs of all participants.