The End of Spread Compression

Summary of the Conference Call Industry Overview - The conference call focuses on the Asia Credit Market, specifically Asia Investment Grade (IG) and High Yield (HY) credit sectors, with insights into their performance and outlook for 2025 [9][10][29]. Key Points and Arguments 1. Current Performance and Outlook - Asia IG and HY have shown strong year-to-date total returns, outperforming global USD credit peers. Asia HY's total return is currently at 14.8%, the highest since its inception in 2013 [29][40]. - The Asia IG spread is forecasted to hold well in the first half of 2025 but is expected to widen in the second half due to increased net supply and US tariff risks [9][10][12]. 2. Themes Influencing Credit Spread Dynamics - Theme 1: Technical Normalization - Asia credit demand is expected to outpace net supply in 1H25, but this trend will reverse in 2H25, leading to wider spreads [10][13]. - Theme 2: Spread vs. Yield Relationship - The current spread for APAC IG is at its lowest relative to yield, indicating limited room for further tightening [11][147]. - Theme 3: Impact of US Tariffs - The potential for increased tariffs on China could lead to manageable spread widening, reminiscent of conditions seen in 2018 [12][147]. 3. Default Rates and Recovery - The default rate for Asia HY is currently at 11.5%, reflecting a decrease in defaults from the China HY property sector, which had previously driven negative returns [40][41]. - The market is now pricing in only three potential defaults, the lowest in three years, indicating a recovery in the sector [40]. 4. Investment Strategies - Suggested trades include switching from China IG to Non-China IG and Japan IG, which are expected to perform better [14]. - Investors are encouraged to buy protection on iTraxx AxJ IG to hedge against US tariff risks [15]. 5. Future Projections - Asia credit is anticipated to start 2025 with historically tight spreads, which could lead to widening as net supply increases [55][68]. - The APAC IG yield is projected to be 5.2%, the second-highest since 2014, despite tight spreads, making it attractive for yield-driven investors [147][150]. 6. Fund Flows and Market Sentiment - Recent inflows into Asia credit funds have been concentrated in Asia credit-mandated funds, while Asia HY-mandated funds have seen outflows [109][120]. - The overall sentiment indicates a shift towards yield-based investment strategies as the Fed is expected to cut rates further [162]. Additional Important Insights - The Asia credit market is experiencing a structural shift, with a focus on diversification into APAC credit to enhance returns [42][53]. - The analysis of the normalization framework for Asia credit indicates that the market is currently in stage 3, where demand is expected to outpace supply for the next few months [107][135]. This summary encapsulates the critical insights from the conference call regarding the Asia credit market, highlighting performance trends, investment strategies, and future outlooks.