Midyear Credit Outlook: An Odd Disconnect in Asia

Summary

Podcast Summary: "Midyear Credit Outlook: An Odd Disconnect in Asia"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: Midyear Credit Outlook: An Odd Disconnect in Asia
• Release Date: June 20, 2025

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Introduction In the June 20, 2025 episode of "Thoughts on the Market", hosted by Morgan Stanley, Andrew Sheets, Head of Corporate Credit Research, and Calvin Pang, Head of Asia Credit Strategy, delve into the intricacies of the Asian credit markets. This episode marks the conclusion of their global tour of credit markets, offering listeners a comprehensive analysis of the current economic landscape in Asia, credit spread dynamics, and emerging opportunities within the region.

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Economic Overview of Asia The discussion opens with Calvin Pang providing a high-level economic overview of Asia. He highlights that while recent talks and potential deals may offer some relief to the region's growth prospects, the impact is expected to be modest. Pang states:

"We do think that tariff uncertainty will linger here and it will keep growth sort of low here. Especially if we do think that capex of the region will be weaker due to tariff uncertainty."
(00:37)

Despite these challenges, factors such as a weaker U.S. dollar and ongoing monetary easing are anticipated to mitigate some of the growth drag. However, the overall outlook remains cautious, with an expected decline of 90 basis points in real GDP growth compared to the previous year.

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Credit Spreads in Asia Transitioning to credit spreads, Andrew Sheets observes an apparent contradiction in the Asian credit market: despite economic headwinds, credit spreads remain exceptionally tight. Pang elaborates:

"No, they're actually really low. They're probably at the lowest since we start having a data in 2013, so definitely like a 12 to 13 year low of the range."
(01:29)

This unusual scenario raises questions about the underlying factors supporting such tight spreads amidst growth uncertainties.

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Normalization of Asia Credit Technicals Calvin Pang attributes the tight credit spreads to strong technical factors, particularly negative net supply dynamics in Asia credit over the past few years, driven largely by China's credit market. He explains:

"The last two, three years is offset by this negative net supply. So you put these two together, we have this very strong technicals that support very tight spread."
(01:54)

Looking ahead, Pang introduces Morgan Stanley's framework for the Normalization of Asia Credit Technicals, outlining four stages of normalization. The current phase, he notes, is Stage Two, indicating that:

"We still have a bit of room to see some further normalization, especially if we don't get rate cuts."
(03:14)

He anticipates that eventual rate cuts, though delayed, will catalyze the normalization process, making credit spreads more reflective of the underlying economic conditions.

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Borrowing in Local Currencies vs. USD Addressing the cost of borrowing, Sheets inquires about the attractiveness of local currency borrowing in Asia compared to U.S. dollar financing. Pang responds by highlighting the rise of foreign issuers in local currency markets, particularly referencing the Dim Sum bond market:

"We are going to see more foreign issuers in local currency market."
(04:08)

He further explains the benefits for global issuers with natural renminbi needs, emphasizing the competitive yields and reduced hedging requirements.

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Dim Sum Bonds: An Overview In a light-hearted moment, Andrew Sheets asks Pang to clarify what a Dim Sum bond is. Pang defines it succinctly:

"Dim sum bond is basically a bond denominated in CNH. So CNH is an offshore Chinese renminbi sort of proxy."
(04:27)

He elaborates on the market's potential, noting the increasing demand from multinationals and the progress in renminbi internationalization, which could position the Dim Sum market as a more globally integrated sector.

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China Property Sector Shifting focus to the China property sector, Pang provides a sobering update on its credit challenges:

"It's been four plus years since the first default started and we went through like 44 China property defaults, close to about 127 billion of total dollar bonds that defaulted."
(06:03)

He underscores that while the default cycle may be nearing its end, recovery remains elusive. Many property developers continue to struggle with restructuring, and the overall sector's return to stability is contingent on broader economic improvements and increased confidence among homebuyers.

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Market Disconnects and Investment Opportunities Reflecting on the initial paradox of tight credit spreads amidst economic headwinds, Pang advises investors to leverage these disconnects by prioritizing high-quality credits. He suggests strategies such as:

"Whether it's switching out Asia high yield into Asia investment grade, whether it's switching out of BBB credit into single A credit, we think, you know, investors don't lose a lot of spread by doing that but they manage to pick out a higher quality credit at the same time."
(07:23)

Additionally, he highlights the significant exposure to tariff risks within Asia, recommending instruments like the Itrax Asia ex Japan CDS Index as effective tools for investors seeking to hedge or gain exposure to these uncertainties.

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Conclusion In wrapping up the episode, Andrew Sheets and Calvin Pang provide a nuanced perspective on the Asian credit markets. While acknowledging the region's economic vulnerabilities, especially related to tariffs and the property sector, they also identify unique opportunities arising from current market dislocations. The discussion emphasizes the importance of strategic investment choices and highlights the potential for normalization in credit spreads as monetary policies evolve.

Notable Quotes:

• "We do think that tariff uncertainty will linger here and it will keep growth sort of low here." – Calvin Pang (00:37)
• "They're probably at the lowest since we start having data in 2013." – Calvin Pang (01:29)
• "We think the Itrax Asia ex Japan CDS index could be a good way to get exposure to tariff uncertainty." – Calvin Pang (07:23)

Final Thoughts This episode of "Thoughts on the Market" offers valuable insights into the complexities of the Asian credit landscape, balancing caution with opportunities. Whether you're an investor looking to navigate tight credit spreads or seeking exposure to emerging markets dynamics, the discussion provides a thorough understanding of the current state and future outlook of Asia's credit markets.

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For more insights and analyses, tune into the latest episodes of "Thoughts on the Market" by Morgan Stanley.

Transcript

[Andrew Sheets]

Welcome to Thoughts in the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley.

[Calvin Pang]

And I'm Calvin Pang, head of Asia Credit Strategy.

[Andrew Sheets]

And today in the program we're going to finish our global tour of credit markets with a discussion of Asia. It's Friday, June 20th at 2pm in.

[Calvin Pang]

London, at 9pm in Hong Kong.

[Andrew Sheets]

Kelvin, thank you for joining us. Thank you especially for joining us so late in your day to to complete this credit world tour. And before we get into the Asia credit market, I think it would just be helpful to frame at a very high level how you see the economic picture in the region.

[Calvin Pang]

We do think that the talks and potential deals will probably provide some reprieve towards the growth of the region, but not a big relief. We do think that tariff uncertainty will linger here and it will keep growth sort of low here. Especially if we do think that capex of the region will be weaker due to tariff uncertainty. A weaker US dollar for example, plus monetary easing will help offset some of this growth drag. But overall we do think that the Asia region could see 90 basis points down in real GDP growth from last year.

[Andrew Sheets]

So we've got weaker growth in Asia as a function of high tariffs and high tariff uncertainty that can't be offset by further policy easing in the context of that weaker growth backdrop. Higher uncertainty. Are credit spreads in the region wide?

[Calvin Pang]

No, they're actually really low. They're probably at the lowest since we start having a data in 2013, so definitely like a 12 to 13 year low of the range.

[Andrew Sheets]

And so why is that? Why do you have this kind of seemingly odd disconnect between some real growth challenges and as you just mentioned, really some of the tightest credit spreads, some of the lowest risk premiums that we've seen in quite some time?

[Calvin Pang]

Yeah, we get this question a lot from clients and the short answer is that the technicals, right, because the last two, three years we've been seeing negative net supply for Asia credit. A lot of that is driven by China credit. And if you look at year to date supply remain still negative. Net supply and demand side for example has not really picked up that strongly but it still offset any outflows that we see. The last two, three years is offset by this negative net supply. So you put these two together, we have this very strong technicals that support very tight spread and that's why spread has been tight historical. And in the last, I would say one to two years.

[Andrew Sheets]

Do you think this changes?

[Calvin Pang]

Yeah, we do think it's changed. We have a framework that we call the normalization of Asia Credit Technicals. And for that to change, essentially our framework is saying that China treasury yields need to go down and dollar funding need to go down. Cheaper dollar funding will bring back issuers. Net supply should pick up. Demand for credit tends to do well in a rate cut cycle. Demand tends to pick up in a rate cut cycle. So if we have this tool support, we do think that Asia Credit Technicals will normalize. It's just that we have four stages of normalization. Unfortunately, we are in stage two now and we still have a bit of room to see some further normalization, especially if we don't get rate cuts.

[Andrew Sheets]

Got it. So, you know, we do think that if Morgan Stanley's yield forecasts are correct, yields are going to fall. Issuers will look at those lower yields as more attractive. They'll issue more paper in Asia and that will kind of help rebalance the market some. But we're, we're just not quite there yet.

[Calvin Pang]

Yeah, we feel like this road to rate cuts has been delayed a few times the last two, three years. And that has really been a big conundrum for a lot of Asia credit investors. So hopefully third time's the charm. Right. So next year is a big year.

[Andrew Sheets]

So I guess while we're waiting for that, you also have this dynamic where for companies in Asia, or I guess for any company in the world, borrowing money locally in Asia is, is quite cheap. You have very low yields in China, you have very low local yields in Japan. How do those yields compare with the economics of borrowing in dollars? And what do you think that kind of means for your market?

[Calvin Pang]

Yeah, I think the short answer is that we are going to see more foreign issuers in local currency market. And we wrote a report in March just to pick on the dim sum corporate bond market.

[Andrew Sheets]

And Kelvin, just to stop you there, could you just describe to the listener what a dim sum bond is and probably why you don't want to eat it?

[Calvin Pang]

Yes. So dim sum bond is basically a bond denominator in cnh. So CNH is an offshore Chinese renminbi sort of proxy. And it's called dim sum because it's like the most local cuisine in Hong Kong. Most. A lot of dim sum bonds are issued in Hong Kong. A lot of these C and H bonds are issued in Hong Kong. And that's why it's have this, you know, sort of nickname called dim sum.

[Andrew Sheets]

So what is the outlook for that market and kind of the economics for issuers who might be interested in it?

[Calvin Pang]

Yeah, we think It's a great place for global issuers who have natural demand for Renminbi or cnh to issue 10 year CGB now is like 1.5, 1.6%. That makes it a very attractive yield. And for a lot of these multinationals they have natural renminbi needs so they don't need to worry worry about the hedging part of it and what. And for a lot of investor base the demand are picking up because we are seeing that renminbi internationalization are making some progress. You know, higher progress in that means better demand for. So overall we do think that there is a good chance that the Renminbi market or the Steam sun market can be a bit more global player or global sort of friendly market for investors.

[Andrew Sheets]

Kelvin, another sector I wanted to ask you about was the China property sector. This was a sector that generated significant headlines over the last several years. It's faced significant credit challenges. It's very large even by global standards. What's the latest on how China property credit is doing and how does that influence your overall view?

[Calvin Pang]

It's been four plus years since the first default started and we went through like 44 China property defaults, close to about 127 billion of total dollar bonds that defaulted. So we are close to the end of the default cycle. Unfortunately, the end of default cycle doesn't mean that we are in the recovery phase or we are in the speedy recovery phase phase. We are seeing a lot of companies struggling to come out of restructuring. There are companies that come out restructuring and re enter defaults. So we do think that is a long way to go for a lot of these property developers to come out of restructuring and to get back to a sort of going concern kind of status. I think we are still a bit far. We need to see the recovery in the physical property markets and for that to happen we, we do need to see the China economy to pick up which give confidence to the home buyers in that sense.

[Andrew Sheets]

Kelvin, we started this conversation with this kind of odd disconnect that defines your market. You have a region that has some of the most significant growth risks from tariffs, some of the highest tariff exposure and yet also has some of the lowest credit risk premiums with these quite tight spreads. If you look more broadly, are there any other kind of disconnects in your market that you think investors around the world should be aware of?

[Calvin Pang]

Yeah, we do think that investors need to take advantage of the disconnect because what we have now is a very compressed spread and we like to be in high quality, right? Whether it's switching out Asia high yield into Asia investment grade, whether it's switching out of BBB credit into single aid credit, we think, you know, investors don't lose a lot of spread by doing that but they manage to pick out a higher quality credit at the same time. We do think that one thing unique about Asia Credit is that we have significant exposure to tariff risk. Asia countries are one of the few that are, you know, seven out of 10 countries that that are having trade surplus with the US and that's why we think that the Itrax Asia ex Japan see CDS index could be a good way to get exposure to tariff uncertainty. The index did very well during the Liberation Day sell off. Now it's trading back to more like normal level of 70, 75 basis points. We do think that for investors who want long tariff risk that could be a good way to add risk.

[Andrew Sheets]

Kelvin, it's been great talking to you. Thanks for taking the time to talk. Thank you Andrew and thank you listeners as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.

[C]

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