Emma Wall: Hello and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Jenny Lee, Product Manager for Fixed Income for Fidelity.
Hi, Jenny.
Jenny Lee: Hi, Emma.
Wall: So, we're here today to talk about fixed income. A bit of background of what's going on in the U.S. and U.K.; very low interest rates and not much pressure to raise them with inflation so low. How does that differ from what goes on here in China?
Lee: Actually, what's quite interesting is that with such low oil prices and low commodity prices for so long now inflationary pressures in Asia have actually been quite low. So, across Asia we've actually seen central banks cutting rates, and China has actually had multiple rate cuts since November, either in the RRR space or also by the PBOC in terms of the official rate cuts.
So, in terms of that lower for longer, I think base rates in this area actually are still trending down which is actually very supportive for fixed income markets, it's actually very supportive for credit and also very supportive for borrowers.
I would say in the last 12 months or so we've actually seen very exciting new developments in China with the onshore corporate bond market. In the past, there wasn't a lot of private enterprises actually issuing onshore. A lot of that was controlled by regulators actually very tight, but over the past 12 months we've seen a lot of private developers, for example, China property developers, who used to be very active in the offshore dollar markets actually getting now into onshore and taking advantage of the lowering interest, of decreasing borrowing costs and being able to tap into that new additional channel.
Wall: And they are quite interesting and distinct markets, aren't they, the difference between the local currency fixed income market and indeed that fixed income market that's through the dollar?
Lee: Yes, absolutely. It's actually quite exciting. In the past, we've had a balloon of new issuance in Asia investment-grade credit as well as Asian high-yield credit, very similar to what you see in the European markets with the new regulations that's going through and bank does intermediation.
A lot of corporations have been going to the debt capital markets to issue new bonds and refinance. That's been very exciting for investors in looking for new investment opportunities and new channels to get involved. We've also seen a lot of new sectors, new companies, fantastic for the investment community as well in terms of new investment opportunities there.
In that sense, in terms of looking at what's going on in dollar versus onshore credit, it's actually quite interesting. So, on the dollar market, we've had a lot of issuance. But like I said, with the onshore development we've had a bit of less issuance in the high-yield space but we've actually had still continuing ongoing issuance in Asia credit itself.
Wall: It sounds like there's a whole breadth of opportunity there because you've got both more bonds and more issuers coming to the market and you've also got rates coming down which of course means that actually the market is going up?
Lee: No, it's actually quite exciting. Like I said, we've seen multiple rate cuts I think coming through in China. We actually are still talking about QE and potential new opportunities, either in Japan, either in China. We know that Indonesia has the opportunity to lower rates as well. They are probably taking a little bit of time waiting to see what the Fed does.
But overall, I think that overall low base rate situation will actually still continue. What's actually quite interesting is that you hear a lot of noise about what's going on in the U.S. and the U.K. and the pressure to raise rates, we're not having those discussions out here in Asia.
Wall: So, the bond rally does continue in Asia?
Lee: Well, it's interesting because I think if we look at where this cycle has been, we think the opportunities are still there. But we still have to be quite mindful that macro growth is coming down a bit and I think that's the balance that we have to watch out for. So, in terms of issuance, we've had a lot of issuance in the last five to six years.
We've had a lot of issuance post the financial crisis in terms of fueling CapEx, rebalancing balance sheets, restructuring debt. In that space given that global demand is actually still quite soft, I think issuance is actually starting to temper out a bit. So it's a lot more focus on refinancing as opposed to issuing for CapEx and leveraging up.
Wall: Should we talk a little bit about risk though because emerging market bonds, it's not the same as buying a gilt, is it? What's the default risk with these bonds?
Lee: Emerging markets have actually been quite low over the last five years given the excessive liquidity that we've had in the system and interest rates being so low. I would say default rates have been held artificially low for some time. So, that's actually been very supportive for credit. That's been very supportive for the markets.
We actually have seen default rates starting to creep up a little bit, but I think that makes sense. When you look at a large amount of issuance that we had in 2009, 2010 and '11, that cycle is starting to come through. So, companies are starting to need to repay.
In addition, with the commodity cycle that we've been in with lower commodity prices, even a lot of those issuers fundamentally the industry still remains quite challenged and we do see companies that are having some pressure in terms of meeting coupon payments or bond payments.
In that sense, we do see default rates starting to trend up slightly, but we have to remember that we have been below historical averages for quite some time.
Wall: I suppose it's just evident of a market that works as well, not all people who borrow will be able to repay their debt?
Lee: Absolutely and we think it's actually a very strong sign of how efficient markets are supposed to work. I think one thing that we're looking at what's going on in China is people do ask about what about rising defaults? And at the moment we haven't seen a lot of defaults coming up in China. China is a big market. There are a lot of companies. But in that sense, we've actually seen a number of companies been able to find additional sources of funding and find sponsor support, find additional sources of liquidity. In that sense, that can't always happen.
And I think in terms of pricing risk, like we were talking about earlier, it's actually quite important for those natural market balances to start to come through and for defaults to start to work into the system. We do think that it will be measured over the longer period of time. We don't think it will be a quick, quick jump to default. We're not going to see a surge in default rates like we had five, six years ago, but we do think that we will start to trend back towards historical averages.
Wall: Jenny, thank you very much.
Lee: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
