The law of supply and demand can at times generate market imbalances. Right now, Asian credit markets are bucking a rout in stocks simply because there aren’t enough new bonds to go around.
On Monday, the difference between the premium Asian and U.S. dollar corporate bonds pay over Treasuries narrowed to 95 basis points, the least since 2008, as measured by two Bank of America Merrill Lynch indexes:
That's 70 basis points lower than the average since January 2008. In less volatile times, it would’ve signaled that international investors are seeing the value of buying debt in the region.
That’s hardly the case, though. The move is due to the drop in new offerings of dollar debentures, as Wells Fargo Securities analysts Nathaniel Rosenbaum and George Bory pointed out in a recent research note. The amount of bonds sold by companies headquartered in Asia excluding Japan and Australia fell for three consecutive quarters last year, the first time that's happened since 2009:
Outside of the lack of supply, there’s very little going on in favor of investing in Asian debt.
For one, the Fed is raising rates, which means bond prices will drop as yields rise. And according to the Bank for International Settlements, corporates in Asia have never owed so much. Second, China is expanding at its slowest pace in a quarter century and third, the local currencies of countries whose companies sold global bonds in the region have all depreciated against the dollar, making it a whole lot more expensive for them to service their obligations. The ones that export commodities, and therefore don't have to worry too much about foreign exchange risks, are seeing the prices of their products tumble.
It's a confluence of factors that balance sheets have started to reflect. The median amount of debt of companies included in Bank of America Merrill Lynch's Asian Dollar Corporate index is now 4.76 times higher than operating income, versus the 3.28 times ratio of U.S. corporations.
Yet, spreads in Asia have been tightening versus American companies. In the words of the Wells Fargo analysts: ``This reinforces the notion that fundamentals remain irrelevant for U.S. dollar Asian credit markets for the time being.''
The danger of a rally driven simply by a lack of supply is that spreads could widen much quicker than they tightened once market volatility subsides and issuance resumes.
That's especially true since demand is also dwindling. Global investors and companies pulled $735 billion out of emerging markets in 2015, the worst capital flight in at least 15 years, the Institute of International Finance said last month. The vast majority of that came from Asia. The IIF predicted another $348 billion will exit developing nations before the end of this year.
For now, it seems the amount of new dollar notes was smaller than what left Asian bond funds, given the market reaction. But as soon as companies rush to sell more debt, those basic economic tenets will almost surely swing the pendulum in the other direction.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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