Fight returns as fright dwindles

IFR IMF/World Bank Report 2014
7 min read

Asia’s debt capital markets, both offshore and onshore, have experienced explosive growth in the past decade, with the pace picking up since the global financial crisis ushered in an era of unprecedented global easy money.

The hope in the region is that this bond market growth is representative of a more sophisticated mindset among issuers and investors. But there are fears that normalised Federal Reserve policy could end this golden era.

“The end of quantitative easing in the US should have put pressure on Asian interest rates and foreign exchange. This view has been challenged by talk of European QE and resulting outflows from the euro into US dollars as well as Asian currencies,” said Herman van den Wall Bake, head of Asia-Pacific debt capital markets at Deutsche Bank in Singapore.

“On balance, we think the carry trade will therefore last longer than initially anticipated and Asian rates, credit and foreign exchange markets will continue to benefit from the artificial liquidity being provided collectively by the Fed, ECB and Bank of Japan.”

Dangerous experiment

QE has more than its share of detractors and there is a school of thought that regards it as a dangerous experiment that contains inherent excesses and one that cannot be withdrawn from without consequent market mayhem.

Certainly, in May 2013, when QE easing was first mooted, Asian capital markets took fright and the issuance window slammed shut for around two months.

Nevertheless, it opened again in convincing fashion and Asia’s solid economic backdrop together with the ongoing quest for yield allowed a record US$142bn equivalent to print from Asia’s offshore primary debt capital markets last year.

Barring nasty accidents, that figure should be surpassed this year. Some US$124bn has printed in the offshore Asian debt markets in 2014 to-date, according to data from Thomson Reuters, and the pipeline is as packed as it has ever been.

Indeed, the buzz phrase for Asia since its remarkable recovery from the financial crisis has been the ”new paradigm” of financing conditions that are on offer to Asia’s institutions and companies.

‘Goldilocks’ conditions

With Asian bond markets offering a classic example of disintermediation away from the loan markets – a certain relief given that European banks have been trimming balance sheets and are not the force in the region’s loan markets they once were – it is easy to understand talk of a new paradigm or “Goldilocks” conditions, where ample liquidity seems to chase just about any issue on the radar, at whatever point on the credit curve.

There have been some idiosyncratic events in the region that have had a positive impact on Asia’s credit backdrop, principally decisive election victories in India and Indonesia, which regional bankers suggest are already filtering through in terms of these countries as a credit proposition. The end to political impasse in Thailand has created a sense of relief and the country is still courted assiduously by bankers in the region.

“Yes, we are already seeing a noticeable change in mindset in both India and Indonesia. Now that the electoral uncertainty is behind us, both the private and the public sectors can decide on their capex plans and how to finance them,” said Deutsche’s van den Wall Bake.

“We have seen a nascent HY market in India being warmly welcomed by investors seeking diversification and Indonesian credits have a deep investor base to tap into. Loan markets are equally eager to gain exposure, so issuers will not lack financing options.”

According to minutes from the June FOMC meeting, QE should end by October and so the market will have a chance to confront “taper terror” much sooner than was expected at the start of 2014, with early 2015 seen as a likely point for the brakes to be put on QE. The question is whether there will be capital flight from Asia, as has been the case during previous Fed increases.

“Balance sheets in the region may not be flush with as much cash as they were, say even three years ago, and household debt as a percentage of GDP has been rising. And we have seen from the sharp fall in the Indian rupee and Indonesian rupiah last year that current account deficits can spook markets,” said the head of DCM at a European investment bank in Hong Kong.

“Still, we think there will be a measured response to QE in the region and not a panic.”

It could be argued that a sufficiently robust credit culture has emerged in Asia since the financial crisis that resilience is now inherent. Investors are far more willing to put in credit work on challenging high-yield transactions, particularly US real money accounts, which are rushing to open regional offices.

Private banks get a lot of flack but they have managed to convince their clients that Asia high-yield is a viable proposition and private banks account for the majority of high-yield bond ownership in Asia. And bank capital loss-absorbing instruments, corporate hybrids and unrated names have all become a staple of Asia’s debt markets in little over two years.

Indeed, the upcoming issuance bonanza from the big Chinese banks in Additional Tier 1 bank capital, which promises to print in the US$100bn region, would have been unthinkable just a few years ago.

“Ensuring that the banks are well capitalised in Asia is crucial to avoiding capital flight. And doing all you can to avoid current account deficits is also crucial during moments when the tide for emerging markets falls and volatility spikes. A measure of Asia’s coming of age in the minds of investors is that the iTraxx IG Asian index is close to all-time tights despite lingering taper terror,” said the DCM head.

Numerous market pundits have pointed to the rise in household debt in Asia as a concern, with many bank customers that have leveraged up to get exposure to the region’s booming property markets never having experienced interest rate rises.

The crucial input will be when, by how much and how quickly the Fed raises rates. Too aggressive a pace could yet spook Asian markets but the odds are for periods of high volatility in the FX and rates markets to be followed by measured normalisation, as has been the case over the past five years.

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Fight returns as fright dwindles