Goldman Says Asian Bond Market May Face Bubble on Inflows

Asia’s bond market is facing a possible bubble after capital inflows surged this year, according to Goldman Sachs Asset Management Co.

Bond funds in emerging Asia took in a net $11.45 billion this year as of Oct. 31, an 85 percent increase from $6.2 billion for the whole of 2011, according to EPFR Global. Yield premiums on Asia’s BBB rated sovereign bonds have fallen 71 basis points this half to 173 basis points more than Treasuries as of Nov. 14, compared with a 52 basis point slide to 164 for similar-rated countries globally.

“If bond demand continues at these levels and distorts prices for a long period of time, the likelihood of asset bubbles increases,” Owi Ruivivar, a Singapore-based senior fixed income portfolio manager at Goldman’s asset management firm, said in a telephone interview. “The main issue with this increased flow of funds chasing emerging market bonds is that prices do not fully reflect economic fundamentals.”

Dollar- and local currency-denominated bond offerings in Asia surged to records this year as low interest rates in the U.S. and Europe heightened the appeal of the higher-yielding assets. Investors are demanding less of a premium for dollar notes in Asia even as the region’s growth is likely to slow to 5.4 percent this year from 5.8 percent in 2011, according to the International Monetary Fund. Yields on local currency debt fell to a record low of 3.56 percent on Nov. 13, according to HSBC Holdings Plc indexes.

Spreads Narrow

“Supply and demand have become the dominant drivers of bond valuations rather than economic fundamentals,” Ruivivar said.

Spreads on dollar bonds in Asia have narrowed 128 basis points this year to 247.2 basis points more than Treasuries on Oct. 19, the smallest gap since since April 2010, HSBC Indexes show.

“Asia’s resilience during the global financial crisis is a big factor attracting overseas bond investors,” according to Ruivivar.

Offerings from Asia outside Japan of $113.4 billion this year have eclipsed the previous annual record of $73.3 billion in 2010, according to data compiled by Bloomberg. Local currency bond sales are at the equivalent of $203.9 billion this year, surpassing the previous record of $195.7 billion in 2011.

Debt Purchases

Debt-buying by the U.S. Federal Reserve and the European Central Bank in September to support the economy have caused yield premiums to decrease, triggering a surge in issuance. The U.S. central bank said at the time that it will probably hold the federal-funds rate near zero until at least mid-2015.

“If an environment where no real interest rates continue, this will push investors to look for higher yields and yields in the entire fixed income complex will move even lower,” said Ruivivar.

The influx into fixed income, particularly in emerging markets including in Asia, is understandable due to the dearth of investment opportunities in higher-yielding products, according to Desmond Soon, Singapore-based senior portfolio manager at Western Asset Management.

Global sales of debt backed by commercial loans has fallen to $121.2 billion from a record $335 billion in 2007, Bloomberg data show.

“Prior to Lehman Brothers, there were a lot more dollar spread products to invest in such as mortgage-backed securities and commercial mortgage-backed securities,” Soon said. “These have all fallen away or have ended up in the balance sheet of the Federal Reserve. So, while we are seeing record issuances of Asian and emerging market corporate bonds in 2012, the reality is that the universe for dollar spread investors has shrunk dramatically compared to before 2008.”

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