Asia Fixed Income Needs a Bigger Map

Summary

About this episode

<p>Our Head of Asia Credit Strategy Kelvin Pang explains why investors would benefit from a broader fixed income market in Asia, with opportunities across more countries, local-currency credit and dollar-denominated bonds.</p><p>Read more <a href="https://www.morganstanley.com/insights?cid=mg-SM_CORP-insights-17607" rel="noopener noreferrer" target="_blank">insights</a> from Morgan Stanley.</p><p><br /></p><p>----- Transcript -----&nbsp;</p><p><br /></p><p>Welcome to Thoughts on the Market. I’m Kelvin Pang, Head of Asia Credit Strategy [at] Morgan Stanley.&nbsp;</p><p>Today – why the challenge in Asia fixed income may not be the region at all, but the way investors have traditionally looked at it.&nbsp;</p><p>It’s Tuesday, October 13th at 8am in Hong Kong.</p><p>Picture this. You’re shopping in a supermarket. As you walk down the aisles, you notice half of them are off limits. It’s unexpected.&nbsp;</p><p>Something similar has happened in Asia fixed income. The region’s fundamentals remain supportive, but the traditional investment universe has become increasingly constrained.&nbsp;</p><p>The pressure began in early 2023, when U.S. policy rates rose above those in much of Asia for the first time since before the Global Financial Crisis. The environment that had supported Asian bond markets for years turned upside down.&nbsp;</p><p>Consider Asia-dollar credit. Issuers have increasingly turned to cheaper local-currency financing, which is shrinking dollar-bond supply. Asia-dollar credit is now on track for a fifth straight year of negative net supply. At the same time, investment-grade spreads have tightened to 55 basis points. That makes Asia investment-grade credit the most tightly valued major credit market globally.&nbsp;</p><p>And investors have taken notice of this. Assets in dedicated Asia credit and high-yield funds have fallen 62 percent from their 2021 peak – from roughly $75 billion USD to around $29 billion USD.&nbsp;</p><p>But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP could rise from $41 trillion USD in 2025 to [$]54 trillion by 2031. That would account [for] roughly one-third of global nominal GDP growth over that period.&nbsp;</p><p>And most importantly investment is also accelerating. Asia’s capital spending could rise from $11 trillion to [$]16 trillion by 2030. That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense, and broader industrial investment all playing major roles.&nbsp;</p><p>The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map.&nbsp;</p><p>That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on U.S.-dollar credit and local-currency government bonds across emerging Asia. APAC fixed income adds convertible bonds and local-currency corporate credit. It also brings Japan and Australia into the mix.&nbsp;</p><p>So, what’s the advantage of this broader map? You see, each of these pieces behaves differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role, with a mostly investment-grade, U.S.-dollar-denominated profile. Local-currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local-currency corporate credit broadens credit and sector exposure.&nbsp;</p><p>Together, they create a more flexible mix of risks across changing economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency-hedged local bonds can benefit from falling rates while limiting foreign-exchange risk. During stagflation, dollar credit can offer more defensive characteristics.&nbsp;</p><p>Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5 percent return with a vol[atility] of roughly 4 percent, depending on allocation constraints. Investors also increasingly need to manage currency exposure as the dollar cycle shifts.&nbsp;</p><p>For years, investors could navigate Asian bonds with a relatively narrow toolkit. Today’s market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it.&nbsp;</p><p>Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.</p>

Key Insights

• Pang argues that Asia fixed income's problems stem from how investors view the market rather than from Asia's economic fundamentals, which show strong nominal GDP growth projected to reach $54 trillion by 2031 and industrial capital expenditure growth to $16 trillion by 2030.
• The speaker claims that traditional Asia fixed income focus on US dollar credit and emerging market local currency bonds is too narrow, and that dedicated Asia credit funds have experienced a 62% asset decline from their 2021 peak because investors lack adequate analytical frameworks to properly evaluate the region.
• Pang demonstrates that an expanded APEC fixed income approach incorporating convertible bonds, local currency corporate credit, Japan, and Australia creates adaptive portfolio characteristics suited to multiple economic scenarios, potentially delivering 7.5% returns with 4% volatility.

Topics

More from Thoughts on the Market

• The Politics of Powering AI

  The U.S. faces a significant energy infrastructure challenge to support AI data center growth, with a projected 57 gigawatt power shortfall through 2028. The bipartisan American Affordability and Jobs Act proposes permitting reforms and requires data centers to cover transmission costs, shifting from voluntary commitments to federal requirements to protect residential electricity affordability.

• Will High Yields Crack the Market’s Resilience?

  Andrew Sheets argues that current interest rate levels are not obviously too high, supported by robust global growth, persistent inflation above targets, and a non-inverted yield curve. However, beneath aggregate market resilience, weaker credits and lower-rated companies face disproportionate stress, suggesting a quality bifurcation similar to 2005.

• High Mortgage Rates and a Stuck Housing Market

  Jay Backow and Jim Egan from Morgan Stanley discuss how mortgage rates have surged to 7.5% (150 basis points since February), driven by rising treasury yields and inflation concerns. This has created affordability challenges for new homebuyers and reduced housing market activity to 40-year lows, though existing homeowners with locked-in rates below 4.5% remain largely unaffected.

• Will Midterms Test the AI Investment Cycle?

  Morgan Stanley's Head of Public Policy Research examines how the midterm elections could affect AI infrastructure investment sentiment, arguing that while the elections may influence the pace and friction of data center development, they are unlikely to fundamentally reshape AI regulation. The key distinction is that state and local governments, rather than federal outcomes, control most of the policy levers affecting data center projects.

• Japan’s Banks Enter a New Era of Opportunity

  Morgan Stanley's Miya Nagasaka argues that Japan is entering a once-in-30-year investment cycle where companies are shifting from excess savings to increased capital spending, creating substantial new opportunities for banks through lending, debt capital markets, and M&A services. Japanese megabanks' return on equity could rise from 10-11% to approximately 15% over the medium term as corporate financing demand grows.