“The current backdrop will likely contribute to a narrow range for yields through year-end.”

Fixed Income Macro

Tighter financial conditions in the weeks leading up to the November FOMC meeting were key to the decision to maintain the fed funds rate target range between 5.25%-5.50%. Long-term rates have since fallen as the labour market loosened and inflation surprised to the downside – 10-year and 30-year US Treasury yields are each around 20 bp lower. Improving financial conditions and lower risk of a government shutdown this year will likely keep the FOMC on hold in December. Policymakers judge rates are already in restrictive territory and increasingly see risks to achieving the price stability and employment mandates as two-sided, however want to see more evidence that disinflation progress will continue. Their stance is based on a resilient US economy that averted recession in 2023 and appears progressing towards a soft landing. The current backdrop will likely contribute to a narrow range for yields through year-end.

Despite concerns about credit valuations, the spread compression so far this month has been impressive – the Bloomberg Asia USD Credit spread is 33 bp tighter month-to-date. Beneath the surface, IG sovereigns are 15-20 bp tighter, China IG 20-40 bp tighter, Korea high beta corporates 15-20 bp tighter, India IG 10-20 bp tighter, Thailand 10-20 bp tighter. Among idiosyncratic moves, China Huarong bonds were 3-4 pts higher after the asset manager announced that it is acquiring 5.0% of CITIC Ltd from CITIC Group for HK$13.6 bn and proposed renaming itself to China CITIC Financial Asset Management. The magnitude and pace of the moves indicates that investor positioning entering this month seemed to be underweight risk. Approaching year-end when both dealer inventories and new issuance tend to dwindle, the setup for a further move tighter/higher could still be there.

In China, Shenzhen’s lowering of the downpayment ratio for second homes from 80% to 40% may pave the way for other large cities to follow. Meanwhile, October new home prices declined 0.6% year-on-year, 0.4% month-on-month. Compared to the previous month, new home prices declined in 56 cities in October vs. 54 in September, increased in 11 cities vs. 15 in September, and were unchanged in 3 cities. Across city tiers, new home prices were -0.3% month-on-month in Tier-1 cities, -0.2% month-on-month in Tier-2 cities, and -0.5% in Tier-3 cities. Policymakers are reportedly introducing a list of 50 property developers eligible for unsecured short-term loans that includes some of the most distressed companies with offshore bonds. Developers on the list may receive much needed onshore liquidity and buy more time to ride through the sluggish market. While policymakers are pushing for equal treatment between POEs and SOEs, private developers are at a disadvantage on credit access, as indicated by the limited issuance of CBIC backed bonds. Developers excluded from the list potentially face an even more uncertain recovery path. Nonetheless, the proposed policy action if implemented effectively is positive overall.

China Property Bank Loans, Bond Financing and Pre-sales Have All Declined

Source: Bloomberg Finance L.P.

Fixed Income Strategies

Given the bond market rally has extended in the past two weeks, yields are unlikely to push much lower without further unambiguously weak data. The recent stretch of softer-than-expected data has allowed investors to price roughly 100 bp of Fed cuts in 2024 including 25% probability of a first rate cut in 1Q24. This degree of easing appears inconsistent with a soft-landing scenario. For cut pricing to extend further needs to be justified by continued softness in data. In the meantime, although the magnitude of daily yield changes remains elevated, the magnitude of weekly changes has dropped, suggesting that yields may be stabilizing around current levels. If rates continue to fall from here without a significant deterioration in the growth outlook for next year, we are inclined to trim duration of bond portfolios.

For European banks, the credit events of 1Q23 are firmly in the rearview mirror. Sector fundamentals are robust with 9M23 net interest income up ~20% year-on-year, average NPL ratio at ~1.9%, broadly unchanged year-on-year, and the average CET1 ratio improving to 15.9% from 15% a year ago. The sector has not only withstood inflationary pressures, but also borne little impact at the bottom line of slowing and/or volatile non-interest income as capital markets activity slowed. This bodes well for the expected wave of AT1 issuance to refinance up to $30 billion of calls in 2024. Extension risk has receded after several issuers recently redeemed at the first call date and most bonds callable in 1H24 are indicated at prices close to par. Expectations that policy rates have peaked or are close to peaking and still elevated spreads are supporting demand. We favour positions in AT1s with high reset spreads for better mitigation against extension risk and short to medium term callable dates (2-4 years) on flat/inverted rate and spread curves.

Wave of European Bank AT1 Potential Calls – And Supply – Looming

Source: Bloomberg Finance L.P.

The Macau gaming sector has performed strongly after a slew of positive rating actions that sparked a 2-4 pts rally across the board. S&P upgraded Wynn Macau to BB- outlook stable, both S&P and Moody’s upgraded their outlooks for Melco Resorts and Studio City (S&P to positive/Moody’s to stable) and lastly, SJM Holdings also saw its outlook changed to stable by Moody’s. This follows a decent set of 3Q23 results for most operators. These developments should help allay concerns that the recovery in the Macau gaming sector will lose momentum due to sluggish conditions in the broader China economy. Despite the rally month-to-date in the broader market, sector spreads currently between 42nd and 55th percentile since the post-2009 period screen as still offering relative value vs India HY (spreads currently between 19th and 43rd percentile) and Indonesia HY (spreads currently between 8th and 20th percentile). We look to maintain positions in Macau gaming operators.

Equities Strategies

We continue to maintain our view the Fed will hold rates steady for the rest of this year while any rate cuts will likely be in 2H2024. We believe US Equities will range trade for the rest of this year. Although we continue to favour large-cap and quality growth stocks in the US, it is important to be selective against a backdrop of overbought AI related plays. We recommend to buy the dip at more reasonable valuations in US technology sector, in particular the AI-related names should a pullback materialise, as well as in defensive sectors such as consumer staples and healthcare, which offers more attractive risk/reward should the US economy enters into a soft landing in 2024. Stay focused on quality industry leaders with significant market share, robust balance sheet and reasonable earnings growth.

For China/HK, we remain cautious in HK/China heading towards year end as investors awaits the November reading on China’s manufacturing PMI data on 30 November. This month’s data will provide more colour on the potential direction of China’s overall economic health. The previous read in October fell below 50 at 49.5, indicating contraction. Any further contraction below consensus will likely result in further pressure on China/HK Equities. A host of recent measures including support for a white list of real estate companies are deemed insufficient and is received with lacklustre response by the market. Against this backdrop, we recommend investors to consider adding HK/China Equities exposure through Index ETFs rather than individual securities in order to mitigate market and P&L volatility. Our preferred sectors are Technology, EV-related and Travel-related industries for individual stocks. We also continue to be advocates of defensive sectors such as Telecoms and Utilities that provide reasonable dividend yields with decent valuation upside. As we continue to monitor key data points, in particular those that could lift the real economy, market sentiment and hence a rebound in Equities, we reiterate that portfolios should stay nimble and diversified.

Overall Equities exposure should remain moderate to low as year-end looms with increasing geo-political tensions and as most of the concerns that plagued global Equities throughout the year still linger. Last but not least, we recommend overall portfolios to remain nimble through tactical swing trades and consider the use of some structured products with downside protection.