JKC Asia Bond 2025 – Fixed Maturity Fund October 2024 Update:

• For the second consecutive month, Asian markets saw extremely volatile moves in equities
• Sudden and aggressive monetary policy stimulus announcements out of China in late September drove a “melt-up” rally in Chinese stocks
• Asian dollar bond reaction was more muted however as skepticism remains as to the degree policies will support the high beta distressed segments of the market
• The Fed began its US interest rate cutting cycle as expected although a 50bps cut was above many economists’ forecast
• Asian bonds showed steady (albeit unspectacular) returns as a steady decline in US yields mostly drove both Investment Grade and High Yield markets
• JKC Asia Bond 2025 returned 0.75% in the month with accruals and pull-to-par  being the main drivers of returns
• October will likely focus on China’s fiscal stimulus actions to complement the PBOC moves.

Despite another highly volatile month for equity markets in September, Asian USD bonds continued their recent trend of stable gains as declining US Treasury yields remained the biggest driver of the asset class. The Investment Grade (IG) market as measured by the Markit ADBI index climbed 1.49% for the month while the High Yield (HY) market (via the AHBI) gained 1.61% over the same period. These moves however belied a massive shift in overall risk sentiment in the region after the Chinese authorities, after several years of delay, finally announced aggressive policies to address the stagnating economy, causing a melt up in Hong Kong and China listed stocks at month end. 

Ahead of the Chinese announcements however the biggest market event was the US Fed enacting its first interest rate cut since 2020. In a widely anticipated move the central bank cut the Fed Funds target rate at its September 18th meeting and although the 50bps cut was greater than the 25bps move most economists had forecast, the cut was broadly in line with market expectations. The ‘dots chart’ released with the Fed’s statement signalled the committee expects a further 50bps of cuts before the end of 2024 followed by another 100bps in 2025. These Fed numbers slightly lag market expectations (of 75bps and 125bps respectively) but nevertheless are a significant shift from the previously released dots forecast in June. This implies the Fed is looking to be more aggressively dovish in the near term by front loading cuts in the next 18 months to head off rising unemployment, which appears to be replacing inflation as the central bank’s most immediate concern.

Interestingly, the forecast of long-term terminal rates (i.e. where the Fed expects the overnight rate will settle at the end of this easing cycle) was not changed from the previously expected 2.75-3.00% range indicating the Fed has not completely dismissed the risk of inflation resurfacing. This is further reflected in the yield curve which has steepened significantly in the past few months with the 2yr-10yr spread ending September at +14bps up from -50bps in mid-June. However, despite the curve steepening driving a relatively smaller yield decline at the long end of the curve, bond yields still fell across the board, helping long duration assets to outperform from a cash return basis. The move in US rates triggered similar rate cutting actions across most developed markets’ central banks although the aggressive 50bps move in the US did fuel further weakness in the USD which has now almost fully reversed its gains seen in the 1H24.   

From an Asian markets perspective however the move by the Fed was massively overshadowed by sudden and largely unexpected stimulus policy announcements out of China. The PBOC, after disappointing the market on September 20th by once again keeping its 1yr and 5yr loan prime rates unchanged, performed a stunning U-turn in the following week by announcing aggressive monetary policy actions at a magnitude unseen for over a decade. Indeed, in a joint press conference held just four days later the PBOC along with market regulators the CSRC and CBIRC unveiled a raft of stimulus measures including cuts to the 7-day & 14-day repo rates, a 50bps cut to the banks Required Reserve Ratio and a 30bps cut to the 1-year medium lending facility. Furthermore, the authorities announced a series of further stimulus measures particularly targeting the property and stock markets which have both been in persistent decline since 2021.

Adding to the resulting market euphoria, the CCP politburo held a meeting two days later signalling aggressive fiscal stimulus measures will soon be announced to compliment the easing monetary policy. In contrast to the apparent uncoordinated and mixed signalling investors have become accustomed to from Chinese authorities in recent years, this was carefully orchestrated messaging to fuel market confidence and halt the persistent post COVID economic decline. The strong acceptance and acknowledgement of the scale of the problems in the Chinese economy with special emphasis on the weak real estate market, on local governments budget issues and on the overstretched banking sector alongside the commitment to fix these issues was highly welcomed by the market, fuelling a massive rally in Chinese stocks. In fact, as of September 30th when China closed for a week-long holiday, the SHCOMP Index had gained 22% from its pre-announcement level.

Interestingly despite the equity market frenzy, the reaction in China’s USD bond markets was much more measured. The Asian HY Index gained 1.61% in September while the move in the China component of this Index was only slightly better at 2.03%. This likely reflects the fact there are very few high beta names remaining in the HY Index as distressed names have already been stripped out. There is also a noticeably higher degree of scepticism among fixed income investors as to whether these stimulus measures would actually translate into a recovery for defaulted China bonds, hence demonstrating a clear divergence in opinion from the more optimistic equity investors. 

For the month of September, the JKC Asian Bond 2025 fund returned 0.75%, taking the ytd return to 4.43% which in turn translates to an annualized 5.90%. This return closely matches the underlying yield of the fund and therefore shows how the portfolio, given its short maturity profile, will continue to see returns predominantly driven by the position carry and pull-to-par. We expect this will continue to result in low volatility and stable gains in the upcoming few months. 

In October we expect the market attention to remain very much centred on China. We highly anticipate details regarding potential fiscal stimulus measures from the central government. We have already seen media reports stating that the government was planning to issue multi-trillions RMB worth of special government bonds to fund its stimulus although specific details have not yet been announced. Nevertheless, we believe the transformation of stimulus into actual impact for the real estate market will take some time given the huge scale and complexity of the problems faced by the sector. We will closely watch for a turnaround in contract sales data and see if extremely weak negative growth performance so far in 2024 will be reversed.