Heartfelt advice! Morgan Stanley's Asia Credit Bond Team: This is the last opportunity for a "defensive shift."

Recently, the Morgan Stanley Asia Credit Bond team released a report, reminding investors that the current moment may be the last opportunity to "shift to defense" in the Asian investment-grade credit bond market.

The report suggests that although Asian investment-grade credit bonds have shown remarkable resilience recently, the pressure of spread widening is accumulating as the impacts of tariff risks and weak demand become evident.

Therefore, Morgan Stanley advises investors to seize the current opportunity of spread narrowing to adjust their investment strategies in anticipation of potential market volatility in the future.

The spread of investment-grade credit bonds (also known as credit spread) refers to the difference between the yield of investment-grade credit bonds and the yield of risk-free government bonds of the same maturity.

When the credit spread narrows, it indicates that investors' concerns about corporate credit risk are easing, market confidence is strengthening, and investors are willing to accept a lower risk premium. This is usually associated with a positive economic outlook and improved corporate profitability.

Conversely, when the credit spread widens, it signifies that investors' concerns about corporate credit risk are intensifying, market confidence is weakening, and investors demand a higher risk premium to compensate for potential default risks. This is typically linked to increased economic downward pressure and declining corporate profitability.

Is the Expansion of Asian Investment-Grade Credit Bond Spreads Imminent?

Despite the general pressure on the global investment-grade credit bond market, the performance of Asian investment-grade credit bonds has been particularly strong.

Morgan Stanley points out that since the beginning of this year, Asian investment-grade credit bonds are one of only two investment-grade credit bond markets globally that have achieved spread tightening, the other being the Eurozone.

In contrast, the spreads of U.S. investment-grade credit bonds have significantly widened this year.

Currently, the spread of Asian investment-grade credit bonds remains around 76 basis points, situated in the middle of the 70-80 basis points range since the beginning of the year. However, Morgan Stanley is not optimistic that this stable situation can continue.

They believe that the risks for Asian investment-grade credit bond spreads are skewed to the upside, moving towards their baseline scenario of 93 basis points in the second half of 2025.

Morgan Stanley's report specifically emphasizes two major risk factors that may lead to the widening of Asian investment-grade credit bond spreads, as follows:

Risk One: Tariff Risk = Economic Growth Slowdown = Widening of Asian Credit Bond Spreads

The report argues that tariff risk will become a headwind facing the Asian credit bond market in the near term.

Asian economies are significantly exposed to U.S. tariff risks. The trade tensions brought about by tariffs will undermine corporate confidence and capital expenditures, leading to a slowdown in economic growth in the region.

Morgan Stanley economists anticipate that the speed and intensity of tariff measures could result in the Asian economy facing a growth slowdown similar to or even more severe than that of 2018-19.

Currently, Morgan Stanley's economists in South Korea have downgraded the GDP growth forecast for South Korea in 2025, expecting the growth rate to decrease from 1.5% to 1.2%

Given the current spread levels of Asian credit bonds, Morgan Stanley believes that the market has not fully reflected the potential impact of tariff risks on Asian economic growth.

Risk Two: Weak Demand for Asian Credit Bonds = Widening Spreads of Asian Credit Bonds

Earlier this year, Asian credit bond funds experienced strong inflows, with inflows in January approaching USD 2.5 billion, far exceeding the average of USD 1.1 billion over the past decade. This was considered one of the key factors that allowed the spreads of Asian investment-grade credit bonds to remain relatively stable.

However, in February, the inflow rate of Asian credit bond funds has significantly slowed, amounting to only USD 641 million.

Despite the inflow amount of nearly 2.5 billion yuan in January, about 40 Asian credit bond funds faced outflows, with only 12 funds receiving inflows, indicating that most credit bond funds are experiencing net outflows.

Considering the current slowdown in inflows to credit funds in February, coupled with significant differentiation in fund flows, the weak demand for credit bonds will lead to widening spreads of Asian credit bonds.

The Morgan Stanley team believes that in light of the aforementioned tariff risks and signs of weak demand for Asian credit bonds, the coming weeks may represent the last window for Asian credit bond investors to adjust their portfolios in preparation for the expansion of Asian credit bond spreads, taking advantage of the current tightening spreads