Reflation Trade Raises Red Flags for These Southeast Asian Bonds

(Bloomberg) -- The reflation trade has been gathering momentum again in recent weeks as shown by rising U.S. Treasury yields and increasing inflation expectations. That may spell trouble for bonds in Indonesia and Malaysia.

The two debt markets are among the most at risk in emerging Asia from climbing U.S. yields that typically accompany periods of reviving growth, according to a Bloomberg study looking at five past episodes of reflation. Among potential reasons for this are their relatively high levels of foreign ownership, large dependence on external trade, and more volatile currencies.

Indonesia’s bond yields rose by an average 46 basis points during the periods examined, versus a mean 39 basis-point increase for Treasuries, or a ratio of 1.2. South Korea came second with a ratio of 0.67, while Malaysia was third at 0.51, the study found. China’s were found to be the least sensitive.

The performance of regional bond markets this month appears to back up the findings. Indonesian bonds have handed investors a loss of 1.1% since the start of January, the poorest return in emerging Asia, while China’s bonds were the top performers, gaining 1.5%.

U.S. 10-year yields have jumped more than 20 basis points in January, reaching an eight-month high of 1.19% this week. This has been partially due to rising inflationary expectations, with U.S. 10-year break-even rates, a market-derived gauge of price growth expectations, rising to the highest level in more than two years.

The re-energizing of the reflation trade has been driven by the global rollout of Covid-19 vaccination programs and the prospect of greater U.S. stimulus after the Democratic Party won control of the Senate following runoff elections in Georgia. President-elect Joe Biden said Thursday that he will ask Congress for a $1.9 trillion stimulus to fund immediate relief for the economy, which will be followed a second broader plan next month.

In the short-term at least, any run-up in U.S. yields may face some resistance from the Federal Reserve, with Chair Jerome Powell still adamant that “now is not the time” to hold a discussion on bond tapering. His comments echoed those made by other Fed officials earlier this week that they’re in no rush to cut back on bond purchases.

This means pressure on emerging Asian bond markets may not be as sizable as the study makes it appear. At the same time though, there are plenty of reasons for bond investors in Indonesia and Malaysia to be wary as the recovery in the global economy gathers pace.

To view the full methodology from the study, click here.

What to Watch

• Malaysia’s central bank meets to review policy on Wednesday, with the odds of an interest-rate cut increasing following the government’s decision to tighten the lockdown and declare a state of emergency. The nation will release inflation data on Friday
• Indonesia will auction 35 trillion rupiah ($2.5 billion) of bonds on Tuesday, and the central bank will hold its rate meeting on Thursday. The Philippines will release trade data on the same day.
• Thailand will publish customs trade data Friday, after export growth has slowed for seven straight months

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.

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