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REAL YIELD WORRIES GRIPS MOST ASIAN BOND MARKET

The deeply negative correlation of stocks and bonds that has persisted for most of the last two decades is not a permanent feature of markets but in fact is contingent on a certain macro regime of low and not volatile inflation.

Despite a Thursday bounce, the S&P 500 remains down nearly 3% this week. Meanwhile, 10-year Treasury yields are up about 6 basis points since the start of the week.

Bonds in South Korea and Thailand appear to be the most at risk in Asia as U.S. inflation expectations increase, Debt from the two nations has been the most sensitive to past episodes when American break-even rates have jumped, based on five past scenarios starting in 2011. Korea’s bonds showed a z-score -- which measures the relationship to the mean -- of 0.81, while Thailand’s is 0.77. That compares with just 0.09 for China and minus 0.01 in India. The vulnerability of Korea and Thai bonds can be attributed to the tight spread of their yields over U.S. Treasuries, and also their susceptibility to imported inflation due to their relatively high reliance on energy imports.

Inflation expectations are higher around the world as record central-bank stimulus has created a mountain of liquidity that is starting to filter through into consumer prices. The U.S. 10-year break-even rate, which measures expectations for future inflation, climbed to as high as 2.59% this week, from just 0.47% in March last year. Those concerns escalated this week with faster-than-expected U.S. inflation figures for April.

The story is somewhat different in terms of real yields. Inflation-adjusted yields in the U.S. -- driven by optimism over growth and expectations for Fed normalization -- show Indonesian bonds have been the most vulnerable, with a z-score of 4.51, followed by Thailand at 2.69.A jump in U.S. real yields tends to boost the dollar, which has a relatively large impact on the high-beta rupiah. Indonesia’s currency weakened about 4% on average during the five periods used for the study, compared with an average of 2% for its five Asian peers.

Indonesian bonds have been the most vulnerable to U.S. real yields It appears therefore that the immediate outlook for emerging Asian bonds will differ depending on whether there is a bigger move in the U.S. in break-even rates or real yields. Whichever it is, all the signs suggest there will still be plenty of focus on CPI data for the foreseeable future.







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