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Rising US bond yields won’t stop Asian equities rally
Steepening curve driven by optimism over global growth rather than fears of policy tightening
25 Feb 2021 | Bayani S. Cruz

The sudden rise in US treasury yields this week is not expected to adversely impact the on-going rally in Asian equities in the long term because the underlying drivers are based more on optimism about global growth rather fears of policy tightening by the central banks.

Although there may be a slowdown in the rebound of Asian stocks as investors evaluate whether the rise in interest rates signals that central banks are about to change their current accommodative monetary policy, there is consensus among asset managers that equities will continue to gain favour among investors.

The US 10-year treasuries have risen around 85bp off its record lows in August of last year, with the 10-year US treasury (UST) yield creeping towards 1.4%, while the 2-year UST has been better anchored. Since the beginning of the year, yield differential between 2-year and 10-year UST has widened from 80bps to 116bps.

David Chao, global market strategist, Asia-Pacific (ex-Japan), at Invesco, says: “Market participants can expect low interest rates for a longer period of time, which is the starting point for the recovery trade that I have been embracing, which includes a modestly positively-sloped yield curve, weaker US dollar, stronger commodity prices, corporate credit outperformance relative to government bonds, and stock market outperformance relative to government bonds.”

“Asian economies are comparatively more cyclical than other regions and Asian equities should disproportionately benefit from this investment cycle,” he adds.

Falling Covid-19 cases

The rally in commodity prices (particularly oil and copper) over the last few weeks and the resilience of Asian currencies versus the US dollar suggest that these trends are taking place against a backdrop of falling new daily Covid-19 cases globally, as well as the accelerating vaccine rollout and the prospect of more fiscal stimulus, according to asset managers.

“The quick steepening of the yield curve is bringing flashbacks of the 2013 taper tantrum, during which the 2s/10s UST differential widened by 80bps in six months,” says Alex Wolf, head of investment strategy, Asia, at J.P. Morgan Private Bank. “Asia markets reacted badly to it. But in the current environment, we think the underlying drivers and implications are quite different. A quick look at cross-asset market moves suggest that the move up in yields is led by optimism about global growth, rather than fears of policy tightening.”

Wolf says a lot of the optimism about global growth will be realized in Asia this year. Drivers for this rebound include: first, strong export growth in region as a result of more fiscal stimulus in the United States, strong tech exports, and normalization of consumption in China; second, rising commodity prices, which will benefit several Asian countries such as Indonesia and Malaysia; and third, the pent-up demand in household spending.

“As labour markets in Asia continue to recover, income growth normalized ahead of consumption growth in the second half of last year. This implies that there is room for a consumption catch-up in 2021,” Wolf says.

Also, Asia’s economic fundamentals are stronger. Current account balance as a share of GDP improved across the board in 2020, which points to an even bigger buffer of US dollar savings for surplus economies, and smaller imbalances for deficit economies. This in turn implies less structural demand for external financing to plug the current account gap in the near term.

Regional inflation

Chao warns that instead of rising US treasuries, Asian investors should keep an eye on accelerating regional inflation and the impact it will have on emerging market economies and risk assets in the region.

“The recent spike in oil prices is concerning, although manageable for many of Asia’s net oil importer economies. Correspondingly, the Chinese PPI (producer price index) recently increased due to a rise in industrial output prices. That said, I still think that some intentional, near-term reflationary pressure is a good thing – this signifies that deflation risks are subsiding,” Chao says.

There are also new monetary policy changes investors should take into consideration, including the fact that the Federal Reserve has implemented a new average inflation targeting approach, which indicates that the US central bank will keep interest rates low even as inflation overshoots its ideal 2% target.

“It’s possible that both US and Asian stocks could see a period of consolidation given the recent frothiness. While the likelihood of a Fed policy change is nil, I wouldn’t rule out an inflation scare,” Chao says.

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