Macro Strategy: Asia’s “high yielders”; DXY correction?

Opportunities in South Korea and Indian bonds; DXY may correct after 10% fall since March.
Duncan Tan, Philip Wee07 Aug 2020
    Photo credit: Unsplash Photo

    Rates: South Korea and India offer highest FX-hedged yields

    Coupon returns in DM bonds are meagre with the average of 10Y UST, Bund, JGB and Gilt bond yields offering just 12bps. Scope for duration returns are limited by the current low volatility environment and to some extent, proximity to the zero bound. Consequently, global bond allocators could be taking a harder look at EM Asia bonds in their search for higher potential returns and yield-enhancing opportunities. Based on fund flows data, we believe that there continues to be limited appetite from global investors to take Asia FX exposures (inflows to local currency EM bond funds have lagged that of hard currency funds). Therefore, many investors are likely evaluating Asian bond yields on an FX-hedged basis (short-term FX swap used to eliminate direct FX exposure of local currency Asian bond), rather than unhedged.

    Across Asia, the highest FX-hedged yields can be found in South Korea (1.34%) and India (1.77%) bonds. In South Korea's case, broadly speaking, interest rates have been slow to normalize post the global deleveraging of March. 10Y bond yields remain high relative to peer Asia low-yielders, likely due to some amount of duration supply pressures. Increase in gross issuances this year is projected to be ~70%, one of the highest in the region. Short-tenors KRW cross currency bases (3Y at ~-85bps) have also been slow to normalize to pre-March levels, allowing global investors (who fund in other currencies) attractive yield-enhancing opportunities. In India's case, high FX-hedged yields are a result of having the steepest curve in Asia. The 2s10s spread of 160-170bps is at least 2 times wider than most Asian peers. Front-end INR funding rates have been dragged lower by RBI rate cuts (YTD 155bps cut to reverse repo rate) and liquidity-injecting operations, while the longer-tenor GSec yields stay relatively elevated. In the region, FX-hedging is prohibitively expensive for Indonesia bonds.

    FX Daily: Is DXY due for a correction?

    The USD Index (DXY) closed at 92.8 on Thursday. Having fallen almost 10% from its peak in March, the DXY is coming against some support levels. The first is located around 92.3, the level that the DXY rebounded from in 2016 into the US election. This is marginally above the next support around 91.8 or the floor of an ascending price channel. These support levels to be taken out to extend the DXY’s fall towards 89. The current sell-off in the USD also resonates with the one during the global reflation trade between January 2017 and February 2018, during which there was an intermittent upward correction to 95 from 91.4 in September-October 2017. With US data starting to surprise on the upside recently, it is prudent to be watchful of a possible correction ahead.

    As for today, consensus expects tonight’s US nonfarm payrolls to be lower at 1.48mn in July from 4.8mn in June. Earlier on Wednesday, ADP employment plunged to 167k from 4.31mn for the comparable months. According to the ISM employment sub-indices, the coronavirus resurgence has hurt employment more in the services sector and less in manufacturing. Another sign that it is not all bad in the labour market was the drop in initial jobless claims to a new pandemic low of 1.19mn for the week ending 31 July. The rise in claims above 1.4mn had been a reason for the pressure on the greenback in the past fortnight. If claims continue to improve in the weeks ahead, it would alleviate earlier worries regarding the expiry of the weekly USD600 jobless payment that expired at the end of last month.

    Apart from the monthly US jobs report, investors are awaiting news on the fresh stimulus package. Republicans and Democrats are still far away from reaching an agreement with negotiations likely to extend into the weekend. The original plan was for a bipartisan deal to be concluded before Senate breaks for summer today. According to US Treasury Secretary Steve Mnuchin, President Trump is prepared to consider executive action to unilaterally deliver new jobless aid and cut taxes which Democrats have pushed back as unlawful. Given the uncertainties, investors and speculators are likely to stay on the sidelines ahead of the weekend.

    Duncan Tan

    FX and Rates Strategist - Asean

    Philip Wee

    FX Strategist - G3 & Asia

    Subscribe here to receive our economics & macro strategy materials.
    To unsubscribe, please click here.

    The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

    DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong.

    PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No.