Asian bond markets continued to draw international investments for the fifth consecutive month in September, though the inflows showed signs of slowing amid concerns about the U.S. Federal Reserve’s future rate-cut decisions and caution surrounding upcoming U.S. elections.

Sustained Inflows but Slower Pace

Foreign investors purchased a net $4.99 billion worth of bonds in key Asian markets such as Indonesia, India, Malaysia, South Korea, and Thailand during September. This marked a significant slowdown compared to the $14.09 billion in net inflows recorded in August. The decrease reflects investor caution tied to expectations that the U.S. Federal Reserve may scale back on aggressive rate cuts, dampening the allure of emerging markets.

The slowdown can also be attributed to heightened global market uncertainties, especially the rising strength of the U.S. dollar and increasing U.S. bond yields. These factors make higher-yielding Asian bonds less attractive in comparison to U.S. assets, which are perceived as safer.

Strengthening Dollar and Rising U.S. Yields Create Headwinds

The U.S. dollar index recently hit a two-month high of 103.397, while yields on 10-year U.S. Treasury bonds reached 4.12%—the highest level in over two months. These shifts followed stronger-than-expected U.S. jobs data and rising inflation in September, which have reduced market expectations for further substantial rate cuts from the Federal Reserve.

This rising yield environment makes it harder for Asian bonds to compete with U.S. assets. The stronger dollar, in particular, has dampened enthusiasm for Asian investments, as investors are more likely to flock toward the strengthening U.S. currency and rising yields in the world’s largest economy.

Political Uncertainty Adds to Investor Caution

The upcoming U.S. elections have added another layer of uncertainty for international investors. Analysts note that political outcomes could have a significant impact on financial markets. According to Saktiandi Supaat, an analyst at Maybank, a potential win by Republican candidate Donald Trump may lead to de-risking behavior among investors due to his previous stance on tariffs and trade. On the other hand, a victory by Democratic candidate Kamala Harris might support a global “soft landing” and encourage a gradual easing of Fed rates.

Asian Bonds in Global Indexes: A Beacon of Optimism

Despite short-term challenges, analysts remain optimistic about the long-term prospects for Asian bonds, particularly due to their increasing inclusion in global bond indexes. This inclusion could provide a significant boost to demand for these assets from institutional investors.

Indian government securities were added to JPMorgan’s Government Bond Index-Emerging Markets in mid-2024 and are set to join Bloomberg’s Emerging Market Local Currency Index by January 2025. Additionally, South Korean government bonds will be included in FTSE Russell’s World Government Bond Index (WGBI) by November 2025, while Indian bonds will join the Emerging Markets Government Bond Index in September 2025.

According to Samuel Tse, an analyst at DBS Bank, “The inclusion of South Korean government bonds into the WGBI could help offset the upward pressure on yields, despite changing expectations for rate cuts. This will especially impact higher-yield markets like Indonesia.”

Outlook for Asian Bond Markets

While the near-term outlook for Asian bond markets is clouded by U.S. dollar strength and rising U.S. yields, the growing integration of these markets into global bond indexes provides a long-term source of optimism. Investors are likely to continue seeking exposure to these markets, particularly as global financial conditions stabilize.

(Adapted from Reuters.com)

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