Navigating The Transition To Moderate Growth And High Inflation

Fed pivot remains in debate

The FOMC raised fed fund rates by 225 bps this year. Markets expect another 50-75 bps hike in the next FOMC meeting in September. The market has ongoing debates between more hawkish hikes due to sticky inflation or a Fed pause at some point in time (i.e., a Fed pivot). Nevertheless, we believe it may still be a bit early for a Fed pause scenario. As recession fears are still looming, we expect the 10-year UST yield to stay at current level in 3Q22 and market volatility may escalate as we still have US inflation and non-farm payroll reports before approaching the next FOMC meeting in September.

China’s growth to marginally normalize in 2H22

The Covid-related lockdowns, sluggish consumer demand, and slowdown in property sales hit China’s economy hard in 2Q22. Furthermore, the mortgage payment suspension in mid-July induces more unease to the Chinese property sector. Though the path to recovery is uncertain alongside the country’s zero-case approach, we continue to look for some improvement in China’s growth in 2H22 with an overall supportive tone in both fiscal and monetary policies.

Onshore China

The 10-year China Government Bond (CGB) yield was range-bound at 2.75-2.85% in 2Q22, in line with our expectations in our last quarterly outlook. China’s GDP is expected to modestly improve in 3Q22 versus 2Q22 on a lower base. The Inflation trend is also worth watching, as it could push the yield higher. Overall, a potentially less loosening trend, higher inflation print, and modest improvement in growth underline our assumption that CGB yield would increase towards the year-end. We think a sustainable yield advantage trend is more important in stabilizing the RMB and capping additional pressure on foreign outflows.

Credit strategy

Our strategy in Asia and China high yield (HY) bonds remains with bottom-up credit selection and sector diversification. We remain cautious about China HY spreads but believe they have already priced in the property cycle and sector consolidation. On the other hand, credit spreads for Asia and China investment grade (IG) bonds should remain resilient on low fallen angel risks and local demand. However, we do not think Asia IG spreads are attractive enough on a relative value basis, despite the waning supply that should support bond technicals in this space. We continue to prefer those with short-end, highly rated IG papers that offer a decent all-in yield.

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