Long bonds in Southeast Asia are set to outperform shorter-dated notes as policy makers turn more hawkish, turning the curve flattening trade into a hot bet.
Bond curves in Malaysia, Thailand, Indonesia, and the Philippines are primed for further flattening as front-end yields rise with rate hike expectations while the longer-end, which remains steep relative to many markets outside the region, eases.
While the Treasury two- and 10-year curve inverted this week, the region’s sovereign curves are still steep, even relative to historical averages. Bond curves in other parts of the world have flattened more aggressively due to early rate hikes, leaving Southeast Asia to play catch up -- and presenting investors with a trading opportunity.
“Front-end yields in Southeast Asia are being pressured upwards, as central banks in the region will have to counter inflation which is accelerating rapidly,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd in Singapore. “Evidence suggests that incremental inflationary pressures are already higher in emerging Asia than in the US.”
The spread between two- and 10-year Indonesia bonds is currently around 220 basis points, or 1.4 standard deviations away from the five-year average gap of 132 basis points. The similar gauge for the Philippines, Thailand, and Malaysia stands at 1.7, 0.7 and 0.6, respectively.
Goldman Sachs Group Inc is among those who expect the rates curve to flatten further in Asia, especially for countries which have been slow to raise rates, as it still appears steep considering the amount of monetary tightening in the pipeline. Persistent inflation surprises on the upside and excessive steepness relative to developed markets and global EM peers will drive this, Goldman Sachs analysts including Kamakshya Trivedi wrote in a note on Friday.
Last week, the incoming governor of Bangko Sentral ng Pilipinas signalled the likelihood of at least two successive quarter-percentage-point hikes. At the same time, Bank Indonesia estimates that June’s inflation may exceed its 2%-4% price target, which would be the first such occurrence since mid-2017. The Philippine and Indonesia central banks are set to announce rate decisions on June 23.
The Bank of Thailand’s split decision on June 8, which came after May inflation rose to a fresh 13-year high, also suggests the rising likelihood of a rate hike in the near term. As a result, Standard Chartered Plc is expecting an off-cycle rate increase in July, as the next scheduled policy meeting is only on Aug 10, Tim Leelahaphan, a Bangkok-based economist at the bank, wrote in a note on Monday.