The outbreak of the COVID-19 has up-ended financial market forecasts for 2020. Although there is little doubt that global growth will be adversely affected by the outbreak, it is too early for major central banks to start responding with interest rate cuts. Asian local currency bonds are expected to drive outperformance of the region while Asian high-yield sector looks attractive for investors willing to look beyond short-term volatility.
Major central banks to adopt wait-and-see approach
As it remains uncertain how long or severe the impact of coronavirus outbreak will be, it is likely that major central banks will adopt a wait-and-see approach while keeping a close eye on how Chinese authorities respond.
We could see China unleash new measures over the medium term to support growth, which could take the form of additional interest rate cuts, loans to support SMEs, or even targeted fiscal stimulus in areas such as infrastructure.
Asian local bonds to outperform, while local currencies face further depreciation
An expected growth slowdown in China will be felt across Asia. To cushion the blow, several central banks are likely to relax their monetary policy and supply liquidity in the market. We expect the likes of South Korea and Malaysia to follow Thailand and Indonesia in cutting interest rates in the coming months.
The combination of well-behaved inflation and the likelihood of interest rate cuts in the future is conducive for local currency bonds and should likely drive outperformance of the region.
South Korea and Malaysia may also announce fiscal stimulus measures similar to those unveiled by Singapore.
Despite these measures, weakness of certain Asian currencies could continue in the short term as a result of the virus threat. This includes the Japanese yen, which has traditionally acted as a safe haven but has recently come under pressure because of Japan’s proximity to the epicenter of the virus.
Diverse impact expected within the corporate bond universe
The impact of the coronavirus will vary from industry to industry. Our credit and equity analysts believe that the auto sector looks vulnerable on the back of disrupted supply chains, particularly for companies that have parts produced in Hubei province. The impact on technology companies will be varied depending on their supply chains.
For commodity companies, the sharp price falls have been a significant headwind. If the virus is contained, there could be some attractive opportunities in this space. This would also be the case for Chinese property development companies.
Broadly, the Asian high yield-sector looks attractive for investors willing to look beyond short-term volatility. Curves are steep and valuations are attractive in this space relative to Asian investment grade and other segments of the high-yield market, including emerging markets. The technical backdrop is also supportive as gross supply is expected to trend downward in 2020, while the investor base is largely domestic with a longer term investment time horizon in mind.
Kenneth Orchard, portfolio manager and member of fixed income investment team, T. Rowe Price
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