FX hedging cost drop sparks debate on Asia bond defence bets

Free Malaysia Today

29-05-2025

Three-month forward implied yields for dollar-won have fallen to around 1.7% this week, the lowest level in more than two years. (EPA Images pic)
SINGAPORE : A decline in currency hedging costs across Asia is fueling a debate among bond investors on whether they should fortify their portfolios with cheap protection or let the opportunity slide.
Three-month forward implied yields for dollar-won have fallen to around 1.7% this week, the lowest level in more than two years, signaling plummeting hedging costs for South Korean bonds.
The same gauges for currencies in Thailand, Indonesia, China and India are also below their one-year averages, according to Bloomberg calculations.
Currency hedging costs are falling at a crucial time for investors funding their holdings in Asia with dollars due to elevated market volatility fueled by US policy whiplash and de-dollarisation concern.
However, investors with the stomach for risk could also look for any further declines in the dollar as it would enhance returns on their local currency assets.
Dollar or euro-funded investors would be more comfortable investing in Asia local-currency fixed income with currency hedges, according to Frances Cheung, head of FX and rates strategy at Oversea-Chinese Banking Corp.
'There has been robust foreign inflows into China's Negotiable Certificates of Deposit (NCD) on the pick-up after hedging, and even if hedged returns narrow further after this, flows may still come in if diversification is the goal,' she added.
An investor who hedges a long position in a one-year China NCD with a 12-month dollar-offshore yuan forward will pocket a return of 52 basis points over US SOFR, or 4.85%, according to Bloomberg calculations.
'Lower hedging costs or higher yield pickup will remain a tailwind for Asia local-currency government bonds, and is the most attractive in China and Thailand,' said Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence.
'Hedging costs have fallen as US front end rates remain high, while Asia front end rates are down on easing expectations,' he added.
Central banks in Indonesia, India, Thailand and South Korea have lowered their key rates by a cumulative 175 basis points so far this year while the Federal fund rate has remained unchanged over the same period.
A drop in forward-implied local currency yields relative to American rates makes it cheaper for US-based investors to go short Asian currencies and long the dollar for hedging against potential foreign-exchange losses on their bond portfolios.
The dollar-baht three-month forward implied yields are two standard deviations below the one-year average.
The same gauge for Indonesia, China and Taiwan stands at -1.40, -1.36 and -0.53 respectively.
Bank of Korea trimmed policy rates by 25 basis points today as was widely expected, while flagging the likelihood of more interest rate cuts to come, which is likely to further drag down hedging costs.
May inflation data from Thailand, Indonesia, the Philippines and South Korea early next month will also set the tone for monetary policies in those nations and therefore their currency hedging costs.