Asian credit markets heading for a hose down

Weakening demand and increasing supply will likely douse interest based on spreads but one country remains a preferred exception.

Despite these declining technicals, Asian credit markets continue to hold attractive valuations, with China the darling pick with its high yield credit and Indian banks relegated to the risky category.

Here's more from Morgan Stanley

We are still strategically constructive on credit but have moderated our global overweight following the strong performance to start 2012. Our key themes for Asian credit in 2012 are: deteriorating technicals and outperformance from China credit.

Still strategically constructive on global credit, but have moderated our overweight: We are still strategically constructive on credit on the back of i) compelling micro fundamentals balancing the macro risks; ii) a sluggish but fixed income-friendly growth environment; and iii) still compelling valuations. However, we have moderated our global overweight on credit following the strong performance to start 2012.

Credit valuations are still attractive: We believe that credit still looks attractive in the global asset allocation landscape, as it has less of a valuation problem than high-quality government bonds do and less of a volatility problem than stocks do today. Credit is also currently compensating well in excess of the historical default rates.

Key theme 1 −Deteriorating technicals: Weaker potential demand and increasing supply estimates both point towards a weakening technical outlook for Asian credit markets in the months ahead. We no longer see ‘technicals’ as a tailwind and instead, at best, a neutral influence on spreads.

Key theme 2 –Bullish on China credit: China high yield credit remains our preferred asset class in Asia. Reflecting our increasingly positive view on credit conditions in China and the correction in valuations, we have raised our overweight recommendation on Asia HY.

Our preferences in Asian credit: i) We prefer HY over IG; ii) within HY, we prefer China Property as China sees improving credit conditions, and we see Asian Miners as the defensive play within the sector; iii) we prefer China Quasi-Sovereigns and Hong Kong Property Developers in the Asian IG space; iv) we are cautious on Indian banks; v) we prefer the long end of the IG curve; and vi) CNY FX puts are our preferred hedge against China hard landing risks.