Schroders: Five reasons support the future prospects of local currency bonds in Asia.

Schroders global has stated that over the past five years, the performance of Asian local currency bonds has been superior to other major bond markets, demonstrating significant resilience in the face of market downturns. According to the Markit iBoxx Asian Local Bond Index, the cumulative return in US dollars has reached 14.8%, far exceeding other benchmark indices. Schroders global believes that with the Federal Reserve initiating a rate cut cycle, improving economic prospects in Asia, its relative independence, and the recognition of international investors, the future of Asian local currency bonds looks promising. The Asian local bond market is mainly composed of government bonds and quasi-sovereign issuers, with high average sovereign credit ratings thanks to good credit indicators (such as debt-to-GDP ratio, external debt ratio, current account balance, foreign direct investment, and growth prospects). Looking ahead, Schroders global sees five main reasons to be optimistic about Asian local currency bonds. First, inflation returning to target provides room for rate cuts in Asia, benefiting local currency bonds. With the Federal Reserve starting a rate cut cycle, Asian rates are expected to benefit, and central banks in the region may also follow suit with easing policies. Most countries have seen inflation return to target levels, leading to relatively high real interest rates. Notably, as the path of the federal funds rate becomes clearer, the Indonesian central bank was the first to cut rates ahead of the Federal Reserve on September 18, lowering rates by a quarter point to 6.00%. A weaker US dollar and expectations of further rate cuts by the Federal Reserve have led to stronger Asian currencies, allowing central banks in the region to focus more on local factors such as economic growth, inflation, and financial stability when formulating monetary policy. Second, as interest rate differentials narrow, the potential for a weaker US dollar is positive. With the Federal Reserve having limited tolerance for further slowing of the labor market and initiating a rate cut cycle for risk management purposes, the bank believes the US dollar has room to fall as interest rate differentials between the US and Asia gradually narrow. It is worth noting that Asian exporters expect the US dollar to strengthen further as they price their exports in dollars. However, as business prospects face challenges, more companies may convert dollar-denominated funds into local currency, which is expected to support the performance of Asian currencies. Third, improving growth prospects in Asia boost market risk sentiment. Benefiting from sustained easing of inflation, loose monetary policies, fiscal stimulus measures, and export growth driven by the tech industry, Asia's economic growth is expected to remain robust. The outlook is particularly optimistic for Southeast Asia, as the region benefits from its downstream positioning in the information technology (IT), artificial intelligence (AI), and electronics supply chain, driving favorable trade dynamics. Overall, the bank believes that this growth trajectory in Asia will help raise sovereign credit ratings in Asian countries and enhance investor risk appetite for the local bond market. Fourth, gaining increasing international investor acceptance through index inclusion. Chinese government bonds have been included in three major bond indices. India is set to be included in the J.P. Morgan Global Bond Index-Emerging Markets (GBI-EM) in June 2024, and South Korea will be included in the FTSE Russell World Government Bond Index (WGBI) in November 2025. As global index providers and international investors increasingly recognize Asian local currency government bonds, this asset class is expected to attract structural inflows from global investors, as their allocation to this asset class remains low. Fifth, attractive risk-adjusted returns and low correlation with other bond markets. In recent years, inflation pressures in Asia have been milder compared to developed markets, primarily due to its relatively prudent fiscal policies and more traditional monetary policies. This has resulted in lower volatility in Asian interest rate markets, with Asian government bonds outperforming other government bond markets (such as the US, G7 group, and emerging markets) in terms of risk-adjusted returns. Additionally, lower correlation with other markets makes Asian government bonds an ideal tool for risk diversification, helping to enhance overall portfolio risk management effectiveness. With several major central banks entering a rate cut cycle, potential downward pressure on the US dollar, strong sovereign fundamentals, resilient growth prospects, and increased capital allocation from international investors, Asian local currency bonds are expected to continue to deliver strong performance.