With Rates Trending Lower, How Should Funds Be Repositioned?

Rate cut has been implemented; medium- to long-term rates are trending lower
Asian high-yield corporate dollar bonds offer attractive yields and diversification benefits
Limited supply and strong demand help support bond prices

The US Federal Reserve's interest rate trajectory has long been a focal point for markets. In August, following dovish remarks from Chairman Powell and signs of labour market weakness, the market broadly anticipated that rate cuts would materialize in the near term. That expectation has now been realized, and market believes there could be another two rate cuts this year. Rather than fixating on the exact timing of each move, we believe it's more important to return to fundamentals and assess the broader rate trend. The truth is that the US interest rate is hovering above its neutral rate, implying a downward path in the medium to long run. As such, it's time to explore alternative placements for funds, aiming for relatively higher income with an acceptable risk level.

The Fed is tasked with a dual mandate: striking a balance between employment and inflation. While the labour market remained resilient earlier in the year, August data revealed signs of softening. The US added only 22,000 new jobs, far below the 70,000-plus anticipated by the market. The easing labour market helped pave the way for the recent rate cut. On the inflation front, US tariff policies have sparked market concerns that inflation could rebound sharply. However, the latest data showed that core inflation in July — excluding energy and food prices — rose 2.9% year on year, slightly higher than June but in line with market expectations. Powell also indicated that the impact of tariffs is likely temporary. Together, these factors created a macroeconomic backdrop conducive to easing.

Asian high-yield corporate dollar bonds offer a diverse universe and risk diversification benefits

An accommodative policy helps drive liquidity towards risk assets. Among them, Asian high-yield corporate dollar bonds offer compelling yields. Their correlation with global assets is low, and their risk profile is also comparatively lower. At the same time, the selection of companies is diverse, spanning markets such as India, China, and Indonesia, and encompassing sectors, including renewable energy, gaming, and commodities. This provides the benefit of risk diversification. A broad investment universe also helps avoid companies affected by tariffs, enhancing portfolio stability. For instance, within India's renewable energy sector, developers have constructed wind and solar power plants to produce energy domestically, generating revenue from onshore and avoiding impact of US tariffs. On the other hand, some Indian oil and gas, as well as metal producers, do export to the US, but the exposure accounts for only a single-digit percentage of their operations. The impact is therefore considered relatively minimal.

Demand outstrips supply, supporting bond prices

Apart from the diversification benefit, Asian high-yield dollar corporate bonds are characterised by robust credit and technical fundamentals. The International Monetary Fund (IMF) expects Asia's GDP growth to reach 3.9% this year, higher than the global average of 2.8%. In addition, as Asia's inflation continues to subside, central banks are implementing more accommodative monetary policies.

This allows companies to raise funds domestically at relatively lower costs, without the need to issue dollar-denominated debt. Scant supply is met with strong demand, which helps stabilise bond prices. Asian investors, including those from China, are drawn to Asian high-yield bonds for their strong fundamentals and appealing yields. Take India's commodities and renewable energy sectors, for example: the former offers a yield-to-maturity of 7-11%, while the latter offers 6-8%. Moreover, the greenback's potential persistent weakness could enhance the ability of companies to service interests and principal payments on their dollar debt. Credit fundamentals of Asian high-yield corporate remain stable, with an average rating of BB-. The market only expects a default rate of 2.3% in 2025.

With the rate cut now a reality, the market expects interest rates to continue trending lower. As a result, capital is likely to keep flowing into risk assets, while returns on cash may decline further. For investors seeking higher income within an acceptable risk level, Asian high-yield dollar corporate bonds remain a compelling option worth considering.