Macro Strategy

SGS duration's fading appeal; tech selloff to hurt Asian FX
Eugene Leow, Philip Wee21 Nov 2018
    Photo credit: AFP Photo

    Rates: SGS duration is no longer that attractive   

    The SGD swap curve has flattened significantly over the past two months. The 1Y/3Y spread is now at 17bps, down from 35bps in the early part of October. Similarly, the 1Y/5Y spread has narrowed by about 24bps over the same period. Most of the flattening is driven by receding Fed hike expectations amid persistent market volatility. Broadly, the market is pricing in two Fed hikes by end-2020 with this translating into 30bps of upside for 3M SGD rates, implying a US-to-SG rates passthrough of about 60%. The passthrough for this year is closer to 75% (the 3M Libor and the 3M SOR are up by 95bps and 76bps respectively thus far this year). Note that a 75% passthrough rate cannot be sustained. Some of this was payback for 2017 when a weak USD kept SGD rates depressed. 
    Interestingly, the 1Y SGD swap did not budge (hovering around 2%) despite the 22bps climb in the 6M SOR since the start of September. Domestic liquidity conditions have tightened somewhat with 3M MAS cut-off yield at 2.06%, a level not seen since 2007. 1M and 3M USD/SGD forward points are also meaningfully higher than where they were four weeks ago. However, upward pressure on 1Y SGD swaps appears to have been offset by a drop in Fed hike expectations. At current levels, SGD rates would be too low if the Fed delivers at least three hikes out to end-2019.

    As a result of flatter SGD curves and widening US-SG curve spreads, extending duration for SGSs is no longer that attractive. One of our best ideas this year was for the ultra-long tenors in the SGS curve to outperform their USD counterparts (see here and here). Since late July, the yield spread between 30Y UST and 30Y SGS has widened by 30bps. We would be wary of chasing this trade (across any of the longer tenors) much further.   

    FX:  US stock woes will hurt Asian FX, not the USD

    Don’t expect Emerging Asian currencies to benefit from the overnight plunge in US stock markets. While the 552-point drop in the Dow has captured headlines, it was the sell-off in US tech stocks that will worry export-led Asia most. Hence, it was hard to ignore that Taiwan reported its sharpest narrowing in its current account surplus to USD14bn in 3Q18 from its all-time high of USD25.6bn in 4Q17. The last thing the region needs is the US economy joining the world’s other large economies – Eurozone, Japan and China – in weakness. Global growth worries were also evident in the sell-off of oil prices and all three commodity-led currencies – the Canadian dollar, the Australian dollar and the New Zealand dollar.

    Within Southeast Asia, growth worries were also fanned by a larger-than-expected fall in Thailand’s growth to 3.3% YoY (vs 4.2% consensus) in 3Q18 from 4.6% in the previous quarter. Before this data release, Thailand was considered one of the region’s outperformers underscored by a central bank paving the ground for a rate hike. This disappointing data has, nonetheless, vindicated Thai equities and the baht from not joining the recent relief rally in the region, which in turn, has led Thai bonds to ignore rate hike risk. Our target remains for the baht to weaken past 33 towards 34 again.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Philip Wee

    FX Strategist - G3 & Asia

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