Spending Boom Means Southeast Asia Yield Curves Will Get Steeper

(Bloomberg) -- Asian governments are turning on the stimulus taps to help counter the ravages of the coronavirus. While the current economic benefits are obvious, there may be a price to pay down the road.

Take Indonesia, where the difference between yields on two-year and 10-year securities is the widest in almost a decade, the starkest indication in the region that markets have been pricing in the longer-term ramifications of a surge in government spending. The trend is similar in Thailand and Malaysia.

Here’s a look at how yield curves are moving in the four major Southeast Asia bond markets:

Indonesia

The nation’s yield curve has been steepening as two-year rates have been driven lower by Bank Indonesia’s interest-rate cuts. A similar decline in longer maturities has been prevented by concern over the outsized budget deficit and possible rupiah depreciation pressures resulting from central bank bond purchases.

Policy makers have lowered their benchmark seven-day reverse repo rate by 50 basis points during the past two months to help prop up faltering growth. Borrowing costs in local money markets have fallen even more, with the overnight index average rate dropping a full percentage point since May, further boosting domestic demand for shorter-maturity bonds.

Longer-dated yields have remained relatively sticky as the central bank has widened its forecast for this year’s fiscal deficit to 6.34% of gross domestic product. Global funds have also turned sellers of the nation’s debt, with net outflows of $291 million in August halting four months of inflows. There may be a continued bias toward rupiah weakness until the extent and permanence of Bank Indonesia’s debt monetization is made clear, according to Bloomberg Intelligence.

Malaysia

The difference between Malaysia’s three- and 10-year yields has been widening as traders have boosted bets on a rate cut at the central bank’s September meeting, which would be a fifth straight reduction. The spread is now around 65 basis points, having more than doubled since the end of last year.

As is the case in Indonesia, concern over the budget shortfall is plaguing longer tenors. The government raised its projection for the fiscal deficit to 5.8% to 6% in June, from 4.7% to 5%, citing the need for additional stimulus.

Investors appear to be shying away from longer-maturity bonds in favor of short-term ones. The bid-to-cover ratio at a 20-year auction last week dropped to 1.5 times, the lowest this year, while that at a three-year sale last month climbed to a 2020-high of 2.51 times.

Thailand

Thailand’s two-to-10-year yield spread is close to an 18-month high, although it may be getting near the end of its steepening journey. An auction of 2049 government bonds last week drew a bid-to-cover ratio of 2.2 times, holding close to this year’s average of 2.35 times. Downward pressure on two-year yields also appears to be dwindling, with swap markets indicating the central bank will stay on hold for the rest of the year.

Nonetheless, there are some reasons that suggest steepening may resume. The correlation between longer-tenor Thai government bonds and their U.S. equivalents is the highest in the region, signaling any spike higher in Treasury yields may spill over into a similar move in Thailand.

Philippines

There’s an exception to every rule. The Philippine yield curve has remained relatively unchanged so far in 2020 despite the government saying its budget deficit will exceed 7% from this year until 2022, a record high.

One of the reasons may be the central bank’s purchases of 800 billion pesos ($16.4 billion) of government debt since the outbreak of the coronavirus pandemic, or an estimated 45% of the country’s domestic borrowings over the period. With the central bank seemingly intent to hold off from further rate cuts, the curve may even have room to flatten.

What to Watch

• Thailand will release customs trade data on Monday, after exports slumped by 23% in June, the biggest decline in a decade. Malaysia will publish trade numbers on Friday
• Indonesia will be conducting a conventional bond auction on Tuesday, with the previous sale on Aug. 11 seeing the best bids since February
• The Philippines is scheduled to auction 30 billion pesos of 20-year bonds on Tuesday

Note: Marcus Wong is an EM macro strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice.

©2020 Bloomberg L.P.