More leeway for Asian central banks to rate cuts as inflation returns to target
Asian central banks are expected to follow the US Federal Reserve's anticipated rate cuts. Inflation across most Asian economies has returned to target levels, creating room for monetary easing. For instance, the Bank of Korea has already cut rates consecutively, as seen in its Nov 28 decision, to bolster growth amid reduced concerns about currency depreciation.
On the whole, expectations of further Fed rate cuts will allow central banks to focus more on domestic drivers such as growth, inflation and financial stability when formulating their monetary policies, which are supportive of Asian bonds in general.
Potential softening of the US Dollar as rate differentials narrow
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Broad indicators in the US still suggest a trend of healthy rebalancing of the labour market, which should support gradual easing by the Fed.
“In this soft landing scenario, we see scope for the US dollar to soften as US-Asia interest rate differentials narrow. Notably, Asian exporters have been holding onto strong earnings in the US dollar, expecting the currency to strengthen further,” says Schroders.
However, as the outlook has now been challenged and more corporates will likely convert their US dollar holdings to local currencies or to hedge US currency risk via FX forwards, Schroders expects Asian currencies to find a stable footing in 2025.
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The key risk to this outlook is a large adjustment weaker in CNY due to the 60% US tariffs on Chinese goods, which might necessitate a degree of competitive devaluation from regional trade partners.
Improving growth prospects in Asia supports risk sentiment
Southeast Asia is set to benefit from fiscal stimulus, monetary easing, and tech-related export growth, particularly in AI and electronics supply chains. Stabilising growth indicators from China further underpin this optimistic outlook.
The outlook for Southeast Asia is particularly positive, as the region benefits from advantageous trade dynamics due to its downstream positioning in the IT, AI and electronics supply chains. The recent data from China also suggests that growth is gradually stabilising, following a significant shift in the policymakers' policy direction.
“Overall, we believe this positive growth trajectory will enhance both the sovereign and corporate fundamentals in Asia, as well as risk sentiment towards the bond markets,” says Schroders.
Attractive investment opportunities in 2025
With market pricing of rate cuts getting a lot more realistic and valuations having cheapened, Schroders looks to modestly increase duration, favouring exposures in Indonesia, India, Mainland China and the US.
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While the USD has scope to soften in the medium term, strong US growth and potential for reflationary Trump policies might limit its downside in the near term.
“We therefore maintain calibrated net Asian currency risks, focusing on relative value trades and favouring domestically oriented high yielders, such as the Indonesian rupiah and Indian rupee, funded by shorts in the Philippine peso, Thai Baht and the Euro,” says Schroders.
Although Asia credit spreads are trading at tight levels, the asset manager sees no fundamental credit reasons for them to widen significantly, and the default rate is likely to decline further in 2025.
“We are constructive on sectors such as financials, India renewables, telecom, Macau gaming and China consumers. However, we are cautious regarding China SOEs (State-owned enterprises), technology and Philippines corporates,” according to Schroders.
In summary, Asia's stable inflation at target levels has created a compelling environment for domestic bond markets, which are poised to benefit from the US easing cycle and policy rate cuts from regional central banks. The growth outlook is optimistic, driven by disinflation, monetary easing, fiscal stimulus and a robust tech-driven export surge.
Furthermore, increasing recognition from international investors, marked by recent index inclusions for Indian and South Korean government bonds, reinforces the attractive positioning of Asian local bonds that are poised to draw significant structural inflows in the long term.
