In the year 2024, sovereign bonds in emerging Asia are anticipated to find greater support from expectations of interest rate cuts rather than currency gains. The possibility of a dovish stance from the Federal Reserve creates room for Asian central banks to accelerate interest rate reductions, thereby bolstering the performance of bonds. However, the resilience of the US economy introduces uncertainty regarding the strengthening of local currencies, which may not be guaranteed to support the bonds.
Alvin Tan, the head of Asia FX strategy at RBC Capital Markets in Singapore, emphasized, “Duration is likely to outperform with the turning of the global interest rate and inflation cycles.” He highlighted that, in comparison, many emerging market currencies may experience limited gains or losses in the first half of the year, as the broad dollar is expected to remain resilient and range-bound.
Asian currencies have faced challenges at the start of 2024, marking the most significant decline in over nine months during the first trading session. Tensions in the Middle East and Europe have contributed to this downturn, while the US dollar recorded its most substantial gain since October.
Historical trends also indicate that currency performance tends to lag in the lead-up to Federal Reserve easing. During the period when the Fed was on pause from late 2018 to late July 2019, the Bloomberg EM Asia bond index reported a total return of approximately 4.90%. While bond prices and income from coupons contributed 5.30% to this, there was a currency loss of 0.4%.
Goldman Sachs analysts, including Kamakshya Trivedi, noted in December that the Fed’s shift allows more room for Asian central banks to ease policy, providing broader duration support. The global disinflation trend enables central banks to respond more aggressively to falling inflation, favoring the outperformance of emerging market duration over currency returns.
The disinflation narrative has taken hold in emerging Asia, with six out of eight nations seeing inflation undershoot economist estimates in November. The lag in price growth behind forecasts was the most significant since March.
Simultaneously, real policy rates in the region are above historical averages, indicating that authorities have leeway to cut rates. For instance, the benchmark rate of Bangko Sentral ng Pilipinas, adjusted for the most recent inflation, stands at 2.4%, 1.5 standard deviations above the five-year average. A similar gauge for Thailand and Indonesia is also approximately one standard deviation higher.
Citigroup Inc. strategists, including Gaurag Garg, highlighted the softening of global core yields and, coupled with a retracement in oil prices, set a favorable backdrop for emerging market Asia duration in December.
