Fixed Income Investment Outlook 1Q 2023
US: Sticky inflation and slowing growth momentum
Strong US job and PMI data have surprised the market on the upside, with the 10-year US treasury yield moving 50 bps higher from early February (7 bps wider YTD). This has led markets to reassess the peak Fed rate and policy path. While a US soft landing or recession scenario remains difficult to pinpoint due to the mixed bag of data, a growth slowdown in the latter part of this year is inevitable, especially after the massive monetary tightening in 2022.
China: Reopening paves the way for normalization; response to policy pivot is key
Most high-frequency data indicate much better economic activities in China after it lifted its Covid-related lockdowns. Chinese New Year-related and overall resumption of activities shall partly buoy GDP growth in the first quarter of this year. Sequential YoY growth should recover more notably in the second quarter on further recovery in consumption, services, and the marginal narrowing declines in property sales, plus a low base effect. Macro policies shall support infrastructure investment, as emphasized in the Central Economic Work Conference (CEWC) late last year, though we note the pace may slow as the financial health of local government levels calls into question lower land sales. Export growth will likely moderate amid the global slowdown.
The 10-year China Government Bond (CGB) yield fluctuated within a narrow range of 30 bps in 2022. It reached the 2022 peak level at 2.95% in early December post-reopening news and finished the fourth quarter at an average of 2.8%. With activities starting to normalize and growth momentum building up, we believe there is room for yields to move higher, or frontloaded, at 3% in the first half of 2023 (more notable YoY impact on GDP in 2Q23 due to low base on Shanghai lockdowns). Nevertheless, we expect the level will likely fluctuate, depending on the speed of economic recovery. The pace of economic growth may start to decelerate in the second half of this year, leading to some moderation in the CGB yield in the same period.
The fundamentals of Asia and China investment grade (IG) remain on solid footing due to low default and fallen angel risks. The credit quality of Asia high yield (HY) issuers should also stabilize after the correction in the credit and property cycle. Moreover, the Asia HY market is of relatively better credit quality than in prior years, with more constituents in the BB space.
Despite the yield compression YTD, we believe the absolute yield levels of Asia and China HY credits remain attractive relative to their peers and provide some cushion against adversity. We selectively trimmed some exposure due to their rich valuations and adopted a more cautious view on the speed of a fundamental turnaround. Peak inflation, fading US dollar strength, and limited net financing should support bond technicals.
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