The 2021 Lunar New Year will usher in a battle-hardened bull. Asia has battled the COVID-19 pandemic fairly well, allowing the region’s economies to recover faster and the credit market to emerge relatively unscathed, with fallen angel and default risks in check. We believe the credit cycle has bottomed judging from recent rating actions and trends in credit metrics. Fallen angle risk is expected to stay low (except among India IG due to sovereign rating pressure) and the default rate should moderate to 2.6% in 2021 from 3.4% in 2020 ytd. Ample global liquidity, epitomized by US$14 trillion of negative yielding debt stock, provides strong technical support that should more than compensate for a marginal waning in demand from China’s onshore investors. Our forecast of US$340 billion of issuance would make 2021 the third consecutive year of record supply, but this will be largely IG-driven and thus should not be too disruptive. That said, we recognize that the low all-in yield for IG could cap returns closer to carry. HY still has room for spread compression as its spread pick-up over IG remains too wide and implies a rather elevated default rate. We expect total return to come in at 4% on the assumption that credit spreads tighten by 30bp to 230bp. We prefer HY over IG, and within IG we prefer corporates over financials.

Asia credit should continue to grind tighter going into 2021 on the back of further signs of a fundamental recovery. Most EM Asia countries have managed to contend with the COVID-19 pandemic relatively well, and this has helped their economies to recover faster. Recovery should accelerate with the vaccine, which would be a big lift to sentiment even if its rollout takes time. This favorable macro backdrop also ties in with some bottom-up observations. There are already early signs that the credit cycle has bottomed and this could be validated by full-year earnings. Also, rating action trends have improved noticeably in 3Q from the 2Q trough and this should continue. These factors should eventually lead to lower default rates, which we expect to moderate to 2.6% next year from 3.2% in 2020ytd.

 Technicals are still supportive in our view. This is despite the fact that Asia could see a third consecutive year of record supply, which we estimate at US$343 billion in 2021. Our supply estimate would translate into US$105 billion of net financing, which would be below recent years' levels. We don’t think this should cause much indigestion, especially considering that three-quarters of next year’s supply would come from IG issuers, who tend to be sensitive to pricing and thus less disruptive to the secondary market. On the demand side, Asia credit should appeal to investors looking for defensive plays and attract its fair share of global liquidity that is expected to remain ample. One development to watch is IG demand from China’s onshore investors given the widening yield gap between onshore and offshore markets, and recent weakness of the USD vis-à-vis RMB. These developments could have an impact on marginal flows but we don’t expect them to stop local commercial bank demand for USD due to asset-liability management needs.