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Welcome back to the Credit Sites No More, Risk, Better podcast. This is Winnie Cesar, Global Head of Strategy at Credit Sites. And today we are going global. We have Zerlina Deng, our head of APAC Credit Strategy, joining us from Singapore.
It's very early in the morning for you, kind of late at night for me. Thus are the perils of having a global team. But also, it's a great way to get some insight into what people are doing around the world in corporate credit and fixed income. Zerlina, thank you for joining me today.
Thanks for having me, Winnie. It's always fun chatting with you. Zerlina, I have to say, you have such a great read on clients, what they're doing, what they're saying. And you recently had quite a trip traveling to Taipei in Hong Kong to meet credit investors.
Can you just give us a quick overview of the different types of market participants that you met and how their views and positions are relevant for fixed income investors outside of Asia, for those of us who may be in the U.S. or Europe? Yeah, sure. Thanks, Winnie.
It was a fun week in Taipei with 38 Celsius degrees, super hot. We met a quite big, wide range of investors. So in Taipei, we met a lot of Chinese lifers, Bank Traverse Team, some of the regional private banks and local investment securities trust company, and as well as some of the trading desk. In Hong Kong, we met a few hedge funds, the syndicate desk, both the global syndicates and regional syndicates, some of the regional and global private banks.
I think it is important and relevant for global investors because these Asian investors, especially the Taiwanese lifers, Chinese lifers, they do have large positions in U.S. territories, and over the past two years, they have diversified to U.S. IG, Euro IG, and some of the EMs out in the corporate space. So their positions and their allocation changes are quite relevant for global credit investors.
In addition, the Taiwanese lifers and the Chinese lifers sometimes as well, they do a lot of FX hedging activity. So this is relevant for the global FX market. Yeah, absolutely. I remember when I was on the trading desk at Wells, when we would roll in the morning, oftentimes around 6 a.m., the first question is always, what was Asia doing overnight?
It really kind of set the tone for the day, and that seems to have continued. Nothing has really changed there. I think what has really changed in recent years is this massive rotation from money market funds and cash bonds, although it seems like there's just cash everywhere. We've seen strong inflows almost across the board, which has been really a technical tailwind for spreads this year, especially in Asia-Ig.
It's been kind of wild. What is your sense for cash levels and funding costs of some of the real money investors that you spoke with during the trip? You know, we know that a lot of the Asia credit investors are a bit more focused on yield, which is still pretty good, versus spreads, which are very, very thin. How are investors right now thinking about target yields, and then how do they kind of achieve those yields?
Is it ratings-based? Is there kind of a matrix of risk and yield? And how are we thinking about duration or reaching down in the ratings spectrum? Yeah, I think the overall sense is the cash level was still very high, probably higher than the pre-liberation days, but slightly lower than the conversation with the clients back in April and May.
I think it's really because we don't have much new supply in Asia, and clients, they still have coupon payments, some of the bond maturities. A lot of them still prefer recycling the coupons in money market instruments for short-dated carry. People don't have very strong consensus in terms of duration, when and how much to put into the long-dated U.S. treasuries or U.S.
credit, so money market instruments, or sometimes floaters are really a preferred instruments for some carry. The funding cost looks still very high in Asia, for some of the bank charges primarily to the interbank facilities, and Three Mountain City is a good reference point, and they are talking about 4.35% for these wholesale dollar funding. For the hedge fund, the prime brokerage-related cost is super high, about 6% to 7%. That also means these type of yield-plus spread investors, it's a tough market for them to gain the spread in the Asia credit market.
A lot of the real-money investors in Asia, my sense is there are still yield buyers. For IG investors, they're targeting 5.5% to 6%. This range for high-yield investors, 7% to 8%. That means it's very challenging if they just invest in the Asia extra-payment dollar space.
Right now, the Asia IG yield is already fully below 5%, and high yield is below 7%. So I think for them, it's a little bit challenging over the next few months. Given spreads are at historical tide levels, most investors agree our view on the preferred duration, staying up in credit quality, and extending duration perhaps to the 10-year part to achieve their target yields. I think in Taiwan, the appetite for duration is a bit higher than China.
The lifers and the banks, they typically target a portfolio duration of about 7 to 8-year, and for the new issues they buy, they're typically looking at 10-years of more than 10-year. In the Hong Kong and China markets, the Chinese real-money investors, they are more comfortable with the 3- to 5-year part of the curve. I think overall, clients are quite agreeing with us in terms of the duration view, and basic duration is a better play in terms of achieving the yield stamp going down in credit curve. But a lot of them say it's easier to play rates than doing the extra credits, given the very flat curve and the limited new issue from the long-dated part.
Yeah, that makes a ton of sense. And we've been telling clients here in the U.S. and really globally, that the rates market does feel like a more enticing place to perhaps add duration to portfolios, because when we start thinking about the shape of the spread curve and some of the potential sensitivities of rates really leg lower, what does that mean for credit spreads? If they really get higher, what does that mean for credit spreads?
A lot of those things give us a little bit of pause. Now, on that topic, I would love to hear what the clients you met with think about our views on the Fed and Treasuries and spreads. As just a note of reference, we came out with a pretty significant change of view, saying that the Fed could be cutting, or at least we expect the Fed to start cutting by as much as 50 basis points at the September meeting. That was after being in a camp of the Fed would be on hold this year, because that July payroll data was just really nasty.
And when we look back at how bad it was and how bad the three-month revisions were, compared to prior cycles, we're kind of at a level where things usually do tend to erode from here. And so that really makes us pretty nervous overall. So, Zerlina, how concerned are Asian investing clients about kind of the outlook of the Fed and rates and spreads? Yeah, I think most clients are very worried about deteriorating labor market in the U.S., also an increased fee of recession.
I feel like the recession wars have been getting more popular among Asian investors over the past one month. Most investors are expecting 25 basis points cut in September FOMC. This is largely in line with the Bloomberg consensus. And they, in general, view our Fed and U.S.
rates view as very dovish, given we're looking at 50 basis points at the September FOMC. But I think overall, in terms of accumulative Fed policy rate cut, most of them are still looking at 100 to 150 basis points. So that's largely in line with our view. It's just the pace of cutting, whether the Fed is being proactive or reactive, is quite different from the Asian clients.
We received quite a strong pushback against our relatively constructive view of long-end U.S. Treasury. The clients are aware the long-end real yield are still quite attractive, but they're very concerned about U.S. fiscal risk.
They're very interested in our 10-year U.S. Treasury fair model, interested in the charts where we put out the historical 2.5 studies, the curve shape when U.S. was in a recession. And a lot of clients are interested in understanding the Fed independence, whether it's going to be more erosional Fed independence, or there will be a complete flip of the Fed governor's board.
So a lot of clients are looking at a March, the Burt, the 10th, and 530s than our first half next year forecast, which I think is 50 basis points. A lot of them are even looking at 100 or above basis points. I think it is quite surprising to me that the clients and investors are still so constructive on the global credit spreads. Most of them expect Asia-U.S.
euro spreads to trade sideways in 2025 at least because of the favorable technicals, the limited supply, especially in Asia, IGN high yield, and U.S. fiscal policies, such as the tax cuts, deregulations. People are very hopeful for that, even though they are aware of the implementation timeline might be disappointing. And some are also hopeful of spreads grinding even tighter if the U.S.
labor market unravels and the Fed conducts very big proactive jumble rate cuts. So it's like a bad news, it's a good news scenario. People are hopeful for very bad labor data over the next couple of weeks. I think just like yesterday, the bill's number was so ugly, but the U.S.
strategy curve was doing okay. And I think a lot of Asian clients are not aware that lower U.S. treasury yields are historically associated with much wider Asia credit spreads as a yield buyer's retreat. So I told them, if we look at historical data, when the U.S.
treasury yields are at 3.5% to 4% disrange, the Asia IG is 150 basis points and high yield is 400 plus basis points. So it's a lot of widening from current levels, and I'm still a believer in mean reversion. But yeah, I think the spread view is even a bigger pushback from the clients compared to our rates view. Yeah, it's so interesting because we have similar conversations in the U.S.
around Fed rate cuts and that being a positive catalyst for spreads from here. And I understand that we have some reference points in 2019 when the Fed was cutting rates a bit more proactively that really supported the market. But spreads were objectively wider by a lot globally as the Fed started that rate cutting cycle. And also the labor market was doing really well or comparatively better than where we have been more recently.
And we also have just so many cross currents of management teams starting to talk more about the focus on profit margins, on potential cost savings. And that is usually a signal to me that we should worry a little bit more about fundamentals. Though I do really have to respect the technical because it has been so strong this year. And on the technical, I think that the financial press has made a lot about Asian investors, especially Taiwanese lifers and some of the Chinese money, getting out of USD assets and rotating back to domestic markets for a wide range of reasons.
But this was especially prevalent as a narrative in April around Liberation Day. Seems to continue to pop up. What is your observation when you talk to investors in these markets? Are we really seeing this massive rotation out of USD assets?
Is it true outright selling? Is it just less buying or is it not happening at all? Yeah, I think in short conclusion, I think people here in Asia still have very strong face in USD assets. Just because of the depth and breadth of USD fixed income market is you cannot find such marketing in Asian local currency, not even in euro or some of the Australian dollar or yen markets.
But in the second quarter, there was a very sharp appreciation of the new Taiwan dollar against the USD. This resulted very large redemptions of USD bonds funds in Taiwan. A lot of the retail investors in Taiwan, they are in leverage positions. They basically borrow their mortgages and invested in USD bonds funds, which it was also a new phenomenon to me.
But because of that, they were already sitting quite a lot of unrealized losses because of the US treasury movement of higher over the past few years. EMS didn't do very well until last year. The new Taiwan dollar movement was almost like a last straw on the camel. So they did a lot of a redemption of their bond fund.
They rotated back to domestic equities. These Taiwanese tech companies were doing great for in the US tech companies. And the central bank was relatively muted back in May. They didn't do a lot of intervention, resulted in this sharp appreciation.
But I think since the third quarter, central bank intervention has largely stepped up. They also limited the exporters from outright selling USD. So new Taiwan dollar has drifted higher since July. And the fund flow has basically reversed, according to conversation with a lot of these Taiwanese funds.
I think the boost in FX volatility reserve from the recent Taiwan insurance regulatory change, the increase in FX hedging ratio in second quarter, and the very significant decline in hedging cost. So to hedge Taiwan dollar in the forward market against USD back in May was like 10-12%, and now it's back to 3% normalized already. So the lifers took a chance to increase their hedging ratio, and they have a lot of comfort to continue allocating to USD fixed income products. But that said, I think a lot of investors are indeed exploring non-USD bonds, particularly here in Asia.
Australian dollar, C&H bonds are very popular in anticipation of this further depreciation of the dollar. So we did some picks of Australian dollar bonds, and this was our trade recommendation since November last year. It did pretty well. Clients are very interested in this, and a lot of them are not hedging their F.
They want to get exposure in the Australian dollar, and they think it will go even higher. And in Aussie bond markets, the average rating is higher than USD, ASI, Japan. There's a quite decent spread pickup, and because of the FX movement, this is really a very hot space. The new issue is also bigger than the ASI, ASI, Japan dollar.
Now, C&H dollar, I think, is a slightly different story. The spreads are very tight because of the demand from local real money insurance and banks. But the new issue market always performed very well. We got clients telling us they would just buy, they would get interbank intraday facility at very low cost, and they will buy the new issue without even looking at the name and the credit quality, and flip in the secondary market, and for sure they're going to make money.
So that's also very interesting. They also don't hedge. C&H is another interesting story because at the start of the year, the offshore C&H rates and offshore C&H rates has a big rate gap, as in the offshore C&H rates are much higher. So coupled with there's a loosening of cross-border fund flow from the Chinese regulators, there has been a lot of fund into the offshore market, and naturally they would prefer buy Chinese names and C&H.
So year to date, it performed very well, until about one month ago, the C&H rates went higher because people are also chasing offshore Chinese equities, and that drove bond fund rotation into the equities and rates went higher, and people suddenly realized all the long-dated C&H bonds they bought into are basically a race trading story and all went underwater. So I think for the new shoes, ever since Timasac, which is about one or two months ago, everything went water. The conversation is that people are waiting for a rebalancing of supply and demand in the offshore C&H market, waiting for more money from Chinese lifers coming down to the offshore market, also waiting for the new shoe supply line to come down a bit. So I think into the second quarter, from the second quarter this year, there has also been some investment strategy change from the investment trust companies in Taiwan, and I think they are increasingly realizing they cannot just be doing passive investments, and they need to compete with the global fund houses.
In the past, for credit investment outside Asia, they usually take advisory services from global funds, like PIMCO, BlackRock, Alliance, Burnside, these ones, but now they want to shift the traditional buy and hold and passive index tracking strategy to active management and create an alpha. Another interesting thing to note is wealth is a very big topic in Asia. In Taiwan, they are coming a bit late to this trend, but the regulator has set up a new trial zone in the Kaohsiung region for financial institutions. They want to promote the development of ultra-high net worth individuals, put it at the wealth management zone to improve Taiwan's wealth management.
So, yeah, a lot of moving parts in Asia. Absolutely, a lot of moving parts. I think that the number of times that we have discussed the popularity of Aussie dollar has just been kind of mind-boggling, because really, how big is that market, especially if there's any sort of focus on liquidity and be able to execute in size? I'd be curious, as you have talked to investors, what positions are most crowded?
You know, what is everybody kind of overly piled into? I would say in the U.S. when we talk to investment grade mandates, it's all about... financials in banks and people think that bank relative value still looks attractive.
Fundamentals still look really good there. Some of the regulation seems like it's going to be a tailwind to the sector. Is there a similar view in Asia on the U.S. banks and what else are people really excited about?
Yeah, outside Aussie dollar, I think it's all about financials. It's also because in Asia, the financials come for 70% of the new supply year to date. And I'm still a corporate analyst and I feel a bit sad about it because yesterday or the day before yesterday, we had 12 deals and there were only like two corporate deals. The financials teams are so busy, but we are a bit sitting on the table.
Anyways, I think the very private position among Taiwanese investors are still the DM financials. U.S. banks, they are also very heavily invested in. Euro financials, mainly the senior papers, some of them to tier two.
A lot of them are also doing Australian Japanese financials. This is very new to supply driven. And GCC financials are also getting very proud of it. We are seeing spreads of these senior papers are tightening 20-30 over the past two months and we have to quickly take profit on our alcohol recommendations on GCC banks, which is a bit rare.
We tend to have a six to 12 months long-term view, but we have to take profits very quickly because of the fast and furious spread movement. There's also increased interest among Taiwanese investment trust companies in sovereigns and corporates, LATAM and senior sovereigns and quasi's, as well as some of the U.S. high-yield BSL and fixed-income related ETF products. We did highlight to them that the credit quality is likely deteriorate over the next six to 12 months, especially in the U.S.
high-yield market, and we see less attractive risk or reward in this market, but they're still interested because high-yield funds, if they're targeting 7% to 8%, that means in the high-yield cash fund, they do have to do some triple C and single B, and they probably still need to get going to the BSL market or even private credit. Absolutely. On the BSL and private credit market, that's for certain a place that I'm a little bit worried about fundamentals. Absolutely.
So what is more hotly debated? What is something that you feel like there's a little bit more of a two-way market? I think one interesting area is Japanese life or sub-debt. It is a bit linked to our earlier topic about FX and the rates movement and impact on regional life insurance.
I think the Japanese life insurance, they hold a lot of JGBs, and because JGB yields are going higher, they're sitting on very big unrealized losses. Most of this for them are classified as hold to maturity, but based on regulatory requirement, they do need to impair if their losses is more than 50%. Not strictly implemented, but this is really a big concern for a lot of the investors. But because of Japanese life or sub-debt, this is still an area you can get some yield.
Most of the real-money clients, they do have positions in this, but they are getting more technical and trading more two-ways, and I think Japanese financials in general, they have more participation from fast money and global real money. So it's more volatile, and during the market downturn, such as Liberation Day or the Middle East escalation of tension, they tend to spread to widen a lot more than the other regional Asian financials. People are still very worried about the persistent spread gap of Japanese lifers with Japan Asia and regional insurance, such as AIA and Prudential, and the large supply coming up from the sector, also the unhashed FX exposure. I think the other debated area is Middle East, GCC banks and GCC corporates.
Despite the increased allocation to the region, people are in general concerned about headline risk, the spread volatility, and interestingly for a lot of Chinese and Taiwanese banks, they already have very large long book exposure to these major Middle East economies. So for their bank treasury team, they feel they need to manage the risk and not to have so much exposure. So the credit line for them is quite limited for Middle East. We also received quite a lot of pushback against our picks in Korean corporates.
I think the Korean equities had a very good performance year-to-date, and FX is transiting because of the new president and improving political sentiments. But people are concerned about the medium-to-long-term perspective of the Korean battery, semis, and auto sector. I think our U.S. analyst has quite a lot about the semis, AI overcapacity, the impact of tariff on the global auto sector.
So this is still front-hand centering investors' mind. They also are worried about increased competition from China and overall oversupply in the Asian market. I think lastly, the area we see a lot of the risk is Indonesia sovereign and quasis. I think that explains the spread volatility over the past couple of months.
People are worried about the increased risk from Dan and Tara, the newly set up sovereign fund, about increased dividend from the quasis sovereigns. So in Asia, the political theme is still a bit volatile, given what happened in Thailand and Indonesia recently, and people still want to stay in DM financials, which explain the crowded positions in these names. Yeah, that definitely makes a lot of sense. So many prospects as it relates to political and the intersection with macroeconomics.
And on that topic, one thing that has blown my mind is all of the trade consternation, the tariff headlines, have not really impacted the markets like they did in 2018, especially when China-U.S. trade deliberations, disagreements were front and center. I would love to hear from you, because you also have a great read on China macro. What are the risks right now?
How are local clients thinking about China macro risks? Does the Chinese economy just matter less to the global economy at this point? I think people are still very interested in China macro, even though the investment allocation, I think a lot of the clients, including Taiwanese ciphers, Japanese ciphers, Korean investors, they basically reduce their Chinese credit holdings to on the way. Some of the Chinese real money guys, they're also decreasing, or not increasing Chinese credit holdings, but that's not because of the macro concerns.
That's mainly because the China credits are trading so tight. They're basically 10, 20 basis points higher than ADIG and the HIG credits, which are already crazily tight. I think the new shoe, limited new shoe, continued negative new shoe supply really explains this, but also because of the China macro has been better than market expectation. We have always hold above consensus view on China macro, and we have recommended investors to continue allocating to China credit.
Since two years ago, the trade has worked out at this point. I think the risk reward is really not that great. But in Asia, people are paying more attention to other markets who have been more favored because of supply chain free allocation, Southeast Asia, Indonesia, Vietnam, but apparently they are also in the crosshairs of U.S. tariffs, especially India.
They're even targeted for buying Russian crude oils and energy products, even though China is buying. I don't think the U.S. has made much noises on that. So it's a bit of a diversion of a tariff-related attention from China to India and other Southeast Asian markets, and China can pull the leverage of rare earths and other aspects with the U.S.
So people are in general less worried about tariffs, but we do see the macroeconomic data slowing down in July, both domestic credit demands, business and consumer sentiments. It's still quite pessimistic. The property market is still going through a prolonged down cycle. The inventory level is super high, and governments or the financial institutions are a bit reluctant to bail them out or inject new money into the sector.
And anyhow, the sector is no longer identified as a growth driver for the Chinese government. And there's still a lot of bad debt in the system. A lot of the defaulted dollar bonds in front of China high-yield property sector still remain unresolved. There's a lot of pending liquidation orders trying to sell their asset offshore, trying to grab their asset offshore.
It's really a very ugly fight between the bondholders and Chinese high-yield property developers. So as an issue of fundamental, it's still not looking good. But compared to the trip in April and May, we do see a lot of regional real money, actually also some global real money and fast money. They're getting into the high-yield China markets, basically searching for yields, because China is really the only high-yield market, I say, in China.
In Asia credits, you could still get above 8%, 9%, or even low-teens that present that type of yield. So the popular areas is double-B China high-yield industrial credits. Some of the state-linked developers, and they also reached down in credit quality in the Cal Gaming sector, given the regulatory scheme and the overall credit fundamental is quite stable, so people are willing to go down to the lowest quality ones. So I think this is also kind of related to the Chinese equity sentiment, which had a very good rally over the past one to two months, and overall macro stance is very supportive.
So people, I feel like this animal spirit towards China high-yield credit is coming back again. It also says the bondholders have very short memory. We heard some comment from syndicates saying WIMAC issued a very long-dated bond, and the bond will only mature after the license end in about seven to eight years' time. Basically, the Macau casino operators will not be able to get such long-dated bond from the low market because the bankers are concerned about the uncertainty coming for the last-license renewal, but different story in the bond market because people are hungry for yields, so as long as you can pay up a bit, there will be demand.
Oh my gosh, that is a lot to digest, and just kind of wild to me sometimes how kind of short-term memories can be for the investor universe. Though, you know, when there's a supportive macro policy stance, that can be so helpful to risk assets. Also, it's helpful to risk assets, especially corporate bonds in Asia as of late, is the technical. We are expecting that U.S.
issuance is probably going to pick up in September. I think that syndicate teams are calling for maybe $160 billion or so issued over the course of the month. Of course, that's very contingent on what does the jobs number look like this week, inflation next week, what does the Fed do? But historically, September is a pretty busy new issue month overall.
What are you expecting for Asia? Do you think that negative new issue supply is going to remain such a strong technical tailwind for Asia? Yeah, I think the technical tailwind is probably going to continue in Asia-X-Japan space. The syndicates are very hopeful for a stronger Asia primary market, but that's mainly coming from the Japanese and Australia financials and corporates.
For Asia-X-Japan, we are still looking at an active new supply of about $20 billion. Year-to-day, the pace of issuance is about 75%, slightly higher than our expectation, but largely in line. I think next year might be a bit faster if rates are really going lower. I think a lot of the issuers, especially from China, Korea, they still need to attack the market for refinancing.
New ticker-wise, Asia-X-Japan, I doubt there will be many new ones, given the funding cost is still very elevated, and we do have a lot of banks willing to give out money, even long-dated ones, to some of the high-quality issuers. I think a lot of the new supply is coming from Japanese IG corporates, some of the utilities trading companies, as well as double issuance. This year, we had NTT, Antikara Farm Circle. This type of issuance will likely continue to come to the market, given the base differential between the angstral yen versus the dollar has narrowed, and the comments from issuers, the hedgehog cost has also come down quite a bit, so Japan will likely continue to be a very active market.
Korean financials corporates as well, because their local regulators want to encourage them to diversify their funding forces, so they're willing to come up to the offshore market, especially the corporate sector. We're still waiting for a quite big issuance pipeline until year-end. I think the investment recommendation we have for investors is really refraining from very aggressively chasing new issues, given this increased supply coming from Japan, Australia, and there is also a chance for hold to maturity, some of this type of real investors also flipping in the secondary market, which make the one or two weeks post-new issuance they're trading, it will be very technical. All right, Zerlina, that was just such an amazing overview of the investment landscape in Asia right now.
Like I said earlier, you do get such great commentary in color from the clients that you speak with, and we appreciate you trekking around to so many meetings in a handful of days in very, very hot weather. I know that that can be both mentally and physically a little bit exhausting. So thank you for joining me today. Thank you everyone who is tuning in, especially those of you watching on our YouTube channel.
Like, share, subscribe. We're trying to grow this channel. And also don't forget, we're doing our special 25 for 25 podcast series celebrating Credit Sight's 25th anniversary of Credit Fundamental Research. It's been a great 25 years.
Thanks, Zerlina. Thank you. Thank you.