Our Head of Asia Credit Strategy Kelvin Pang explains why investors would benefit from a broader fixed income market in Asia, with opportunities across more countries, local-currency credit and dollar-denominated bonds.

Read more insights from Morgan Stanley.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Kelvin Pang, Head of Asia Credit Strategy [at] Morgan Stanley.

Today – why the challenge in Asia fixed income may not be the region at all, but the way investors have traditionally looked at it.

It’s Tuesday, October 13th at 8am in Hong Kong.

Picture this. You’re shopping in a supermarket. As you walk down the aisles, you notice half of them are off limits. It’s unexpected.

Something similar has happened in Asia fixed income. The region’s fundamentals remain supportive, but the traditional investment universe has become increasingly constrained.

The pressure began in early 2023, when U.S. policy rates rose above those in much of Asia for the first time since before the Global Financial Crisis. The environment that had supported Asian bond markets for years turned upside down.

Consider Asia-dollar credit. Issuers have increasingly turned to cheaper local-currency financing, which is shrinking dollar-bond supply. Asia-dollar credit is now on track for a fifth straight year of negative net supply. At the same time, investment-grade spreads have tightened to 55 basis points. That makes Asia investment-grade credit the most tightly valued major credit market globally.

And investors have taken notice of this. Assets in dedicated Asia credit and high-yield funds have fallen 62 percent from their 2021 peak – from roughly $75 billion USD to around $29 billion USD.

But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP could rise from $41 trillion USD in 2025 to [$]54 trillion by 2031. That would account [for] roughly one-third of global nominal GDP growth over that period.

And most importantly investment is also accelerating. Asia’s capital spending could rise from $11 trillion to [$]16 trillion by 2030. That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense, and broader industrial investment all playing major roles.

The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map.

That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on U.S.-dollar credit and local-currency government bonds across emerging Asia. APAC fixed income adds convertible bonds and local-currency corporate credit. It also brings Japan and Australia into the mix.

So, what’s the advantage of this broader map? You see, each of these pieces behaves differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role, with a mostly investment-grade, U.S.-dollar-denominated profile. Local-currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local-currency corporate credit broadens credit and sector exposure.

Together, they create a more flexible mix of risks across changing economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency-hedged local bonds can benefit from falling rates while limiting foreign-exchange risk. During stagflation, dollar credit can offer more defensive characteristics.

Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5 percent return with a vol[atility] of roughly 4 percent, depending on allocation constraints. Investors also increasingly need to manage currency exposure as the dollar cycle shifts.

For years, investors could navigate Asian bonds with a relatively narrow toolkit. Today’s market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Markets have remained resilient despite the prospect of higher-for-longer rates. Our Global Head of Fixed Income Research Andrew Sheets considers the risks building beneath the surface.

Read more insights from Morgan Stanley.

----- Transcript -----

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.

Today, exploring further the question that seems to be on everyone's mind: At what point do higher rates become a problem for markets?

It's Friday, October 9th, at 2pm in London.

We recently hosted Morgan Stanley's ninth annual European Credit Conference here in London. Fifty companies, over a thousand investors, and to some extent, one dominating question.

The market has been impressively resilient this year – but as yields rise, at what point does this change?

I think a good place to start with this question is whether the current level of interest rates are obviously wrong. And I don't think it's clear that they are. Growth in the U.S., Europe, and Asia remains surprisingly robust and has for a lot of this year. Meanwhile, inflation across regions is still generally above central bank targets.

Too high, and a sign that conditions are more likely too hot than too cold. That's the opposite of what the wrong level of rates would imply – as rates that were too high would be curtailing activity and pushing inflation down below target.

Thanks in part to the scale of AI spending and how insensitive the spending has been to the level of interest rates; we're just not seeing this.

I think the yield curve is also confirming this message that the level of rates for now is okay. In an environment where the market thinks that central banks have raised rates too much, it will often so-call invert the yield curve. Pushing short-term interest rates above longer-term ones on the belief that rates that are too high today will need to be lowered when conditions weaken in the future.

We're not seeing that, and that is, I think, a pretty important indicator.

At the risk of being pedantic, I think there's also the premise of the question around resilience. At one level, without a doubt, markets have been impressively solid given the large rise in yields this year. U.S. and European stocks have been posting double-digit gains. Credit spreads, a measure of risk premium, sit near multi-decade lows.

But under the surface, that resilience isn't so apparent. Spreads on the lowest-rated credits, so-called triple CCCs, have increased significantly this year across both the U.S. and Europe. Publicly traded BDCs, which contain portfolios of lower-rated private credit, have traded at widening discounts to their book value.

And even in the mighty U.S. stock market, my colleague Mike Wilson and our U.S. equity strategy team note that over half of the 3000 largest stocks have seen a drawdown of at least 20 percent since June, which happens to be the month that yields started to rise.

2026 may be showing that global growth overall is just less sensitive to higher rates than was initially expected. Large government deficits in the U.S., Europe, and Asia, and large spending on AI may be two reasons why. With growth strong and inflation still too high, rates may be simply seeking out a level that they think will keep things in balance.

But the interest rate that helps balance – this technology and spending boom – are not the same rates that keep a smaller, weaker, or a more indebted company happy. If higher rates are needed to balance things overall, the weaker tails of the market can still suffer.

We've seen this in the past, particularly 2005. When simultaneous booms in CapEx in China and the U.S. housing market pushed up rates back then, the overall economy held up for several more years, while weaker pockets of credit suffered more quickly.

Back then, a large U.S. government deficit, booming China CapEx, and significant U.S. housing wealth all helped push up rates. The overall economy held up for several more years. But weaker parts of the credit market were challenged by those rates more quickly.

We think the same may be true today and therefore favor an upper quality bias. We favor high-yield bonds over loans and decompression across credit indices.

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.