Portfolio managers at US fixed income manager PIMCO, which has $1.74 trillion in AuM at the end of December, discuss the Asia-Pacific market outlook in 2024 and investment implications.

Stephen Chang, Tadashi Kakuchi, Adam Bowe, and Subhash Ganga at PIMCO believe that the US Federal Reserve potential rate cuts should stabilise the Asia credit market overall, but will have a mixed impact on the region’s economies.

After major developed market economies showed surprising resilience in 2023, they anticipate a downshift towards stagnation or mild contraction in 2024. “Inflation in developed markets is finally easing, hiking cycles are ending, and attention has shifted to the timing and pace of eventual rate cuts,” they said in a note.

In Asia Pacific, where markets are as diverse as its cultures, the outlook for each economy varies. “Those with more interest-rate-sensitive, variable-rate debt markets, such as Australia and New Zealand, are likely to slow at a faster rate, led by weaker consumption growth,” they continued. “In emerging Asia, robust domestic demand and the US Federal Reserve’s planned cuts should support sustained, albeit moderated, growth. Meanwhile, Japan looks headed for potential hikes as it departs from 25 years of deflation,” Chang, Kakuchi, Bowe, and Ganga added.

Here are four things they are watching in Asia in 2024 – and what that means for investors.

1. Term premiums could rise as Japan phases out ultra-loose monetary policy
While central banks in other developed markets have paused rate hikes or are planning rate cuts this year, they expect the Bank of Japan (BOJ) to abolish its negative interest rate policy (NIRP) by the March or April Monetary Policy Meeting, followed by a modest policy rate hike from -0.1 per cent to 0.25 per cent. The ultra-loose monetary policy that Japan has pursued for the last 20+ years looks set to be finally phased out.  Despite a bruising start to 2024 with the Noto Peninsula earthquake on New Year’s Day, they anticipate minimal macroeconomic impact on the Japanese economy, and project real GDP growth of around 1 per cent year-on-year for 2024.

2. Market sentiment towards China may shift
The sentiment around China’s economy has been overwhelmingly bearish due to persistent headwinds, including a fragile property sector, geopolitics, demographics, and debt. But Chang, Kakuchi, Bowe, and Ganga believe that the Chinese government’s focus on several strategic sectors could help offset some of the drag. Their baseline forecast is for annual GDP growth to slow from 4.5 per cent to 5 per cent in 2024 from 5.2 per cent in 2023.

They expect supportive – but not aggressive – stimulus measures, with fiscal resources directed towards infrastructure investment in leading-edge sectors, such as the digital economy and artificial intelligence (AI).

Chang, Kakuchi, Bowe, and Ganga believethat monetary policy will likely remain accommodative, with credit growth at around 9.5 per cent year-on-year. They anticipate minimal regulatory tightening and incremental support for the private/commodity housing market, aimed at stimulating demand and ensuring the completion of unfinished projects. However, they predict another year of contraction, with housing fixed asset investment falling 3 per cent to 5 per cent year-on-year.

3. Fragile Australian households to struggle
The Reserve Bank of Australia (RBA) started increasing rates later and hiked at a more gradual pace than other central banks. They think that the RBA is close to, if not already at, its terminal policy rate for this hiking cycle – about 1 per cent lower than the Fed Funds Rate.

In their view, the current cash rate level is as tight as households have experienced in Australia. They expect household spending to deteriorate further over the coming quarters, leading to softer business confidence and a weaker labour market. “These dynamics should allow the RBA to begin an easing cycle in the second half of 2024,” they said.

4. India and Indonesia leading the wave of strong growth momentum
Chang, Kakuchi, Bowe, and Ganga are especially constructive on India’s economy and forecast strong GDP growth of around 7 per cent year-on-year in 2024, driven by resilient domestic demand, as well as strong growth in capital expenditure.

Despite weaker foreign direct investment, foreign portfolio investment is improving significantly, which they estimate will create a $50 billion balance of payments surplus in 2024, versus a $9.1 billion deficit in 2023. This is due to strong equity market performance and the anticipated inclusion of Indian government bonds in global emerging market bond indices later this year.

They are equally positive on the outlook for Indonesia and forecast stable GDP growth in 2024 at around 5 per cent yoy. Although they expect a small current account deficit of -1 per cent this year due to lower commodity prices, Indonesia’s economic prospects remain promising, they said. Among other Asian emerging markets, they expect strong real GDP expansion in the Philippines and Vietnam. Emerging markets finished 2023 on a strong footing, and they continue to see space for some EM Asia currencies to appreciate.

Investment implications
“The Fed’s expected rate cuts, which would cause US treasury yields to fall and the dollar to weaken, will have varied implications for Asia Pacific economies,” Chang, Kakuchi, Bowe, and Ganga said. Over the cyclical horizon, given Australia’s rate-sensitive market, they favour an overweight to long-dated Australian Commonwealth government bonds, with 10-year rates likely to outperform Treasuries.

They expect Japanese rates to underperform global rates given the BOJ’s gradual policy normalization in 2024 and the rise in term premium. They favour an underweight position to Japanese duration.

Interest rates on 10-year China government bonds (CGBs) are expected to have relatively low volatility and be range-bound at around 2.5 per cent with limited correlation to treasuries, they said. Between CGBs and policy banks, they favour an underweight to the latter, given tight spreads and upside surprise in supply from their role in the pledged supplementary lending programme.

Indian government bonds offer value, in their view, with 3+ per cent real yields on 12-month forward inflation estimates. The same goes for Indonesian government bonds, which offer nearly 4 per cent real yield even on a spot inflation basis and have favourable demand-supply dynamics. They are positive on the Indonesian rupiah and Indian rupee as they expect reform-based governance to continue post-elections and the economies to remain secular drivers of emerging market growth.

In Asia credit, they expect more issuance this year after a rather dry 2023, supported by reinvestment demand from bond maturities. In investment grade credit, they see opportunities in some Japanese banks, as well as Australian companies in defensive sectors that are less exposed to discretionary household spending and that are expected to benefit from strong population growth and elevated – though moderating – inflation, such as toll roads and regulated utilities. For high yield, they see value in select Chinese and Indonesian companies.