Entering into vaccine-driven normalization

2020 closed with a diminishing risk premium, as vaccine hopes and expectations of a growth rebound solidify. Massive policy easing in 2020 was much needed in calming markets while coping with the economic shocks brought by COVID-19. Into 2021, the vaccine rollout, accommodative monetary policy and fiscal stimulus should fuel a further growth recovery globally. Market optimism could wane over time due to the fear of diminishing liquidity support from 2H21 and a slow vaccination rate, eventually resulting in greater market volatility. We believe such an environment presents better investment opportunities as valuations have also shifted higher.

Closer to home, we believe the growth in Asia and China would outstand with a faster recovery. Central banks in Asia are likely to maintain an easing bias under low inflation pressure. The prospects for a better growth outlook in Asia and the sustained strength in CNY should also bode well for the region’s dollar bond market and attract fund flows given the ongoing quest for yield.

Key macro themes in 2021

Vaccine outlook matters in reviving growth: A high vaccine efficacy rate should pose upside risks to the global growth recovery. Acceleration in vaccination rate and additional stimulus package could reset the global GDP growth higher. The U.S. real GDP growth is broadly revised upward to c6% from c5% in 2021, post Georgia runoffs. The market may underwhelm on the slower-than-expected vaccination rate and extra rounds of lockdown. That should prove temporary as vaccine distribution is considered a top priority globally. A gradual shift to higher growth expectations will occur in the coming months, with more references to a taper in the later part of 2021.

A steepening yield curve: The Georgia runoffs raises the possibility of additional stimulus after US$900bn announced in December 2020. After crossing the 1% mark, the 10-year U.S. Treasury yield is set to march higher on an additional fiscal stimulus and reflationary pressure in the U.S. That said, from the current level of 1.1%, the pace of increase is likely modest, touching 1.25-1.5% by end-2021. Inflation in 2Q21 will trend higher due to a low base. Unless oil price surprises on the upside, inflation may stay structurally low in the next one year. With the Fed’s attempt to overshoot 2% inflation, the possibility of near-term rate hikes is very remote.

Sanctioned China SOEs a risk or an opportunity?: The U.S. imposed sanctions on 31 Chinese state-owned enterprises (SOEs) from November 2020 and three major Chinese telcos were added to the list in December. This has triggered a knee-jerk sell-off in some China SOE bonds (16 entities out of 31 companies have bonds outstanding) given index exclusion risks (JACI, EMBI). These 16 entities accounted for 3.7% of the JACI index. Per our estimates, Chinese tech like Tencent and Alibaba bonds accounted for 2.5% of the JACI index. The recent decision by the US against banning investment in Chinese tech have revived market sentiment. Furthermore, Chinese three oil names are still the under the spotlight of becoming the next target. We estimated those bonds will constitute c2% of the JACI index.

The U.S. investors are permitted until 11 November 2021 to divest the bond holdings of 16 entities, hence technical should remain heavy in the near-term. It could result in bonds changing hands from the U.S. to Chinese-based investors given cheapened valuations and limited impact on fundamentals. Notably, spread widening (c100bp since November 2020, 10yr is yielding at c4.5%) was more severe in the curve of a national chemical company in China, given its higher revenue generation from the U.S. While we do not envisage the U.S. will change its stance on China after Biden takes over the reins, we foresee a more predictable approach to the U.S.-China relations would fade the risk on the overall China USD bond market.

China growth to outshine, fading credit growth should not pose a major threat: We see a stronger rebound in China’s GDP growth at c8% in 2021 (2% in 2020, 6% in 2019), led by exports and domestic consumption. A slowdown in China’s credit growth will occur concurrently as growth picks up. Nonetheless, the focus on financial stability should keep onshore default rates in check and steady onshore yield to keep refinancing risks under control. Overall, tighter regulations will continue to drive deleveraging and greater credit differentiation for the property sector, which should further stabilize developers’ credit profile and underpin their bond performance in the medium term.

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^{The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable as of the date of presentation, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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