Victor Yong Victor.YongTC@uobgroup.com Global Economics & Markets Research Email: GlobalEcoMktResearch@uobgroup.com URL: www.uob.com.sg/research Friday, 28 April 2017 SIBORs & SORs April MAS, maintaining the extended stance MAS maintained their neutral policy stance at April's semiannual meeting. The SGD NEER slope remains at 0 while the midpoint and width of the policy band were also left unchanged. This outcome was in line with analysts' consensus expectations, but the statement was deemed to be slightly more dovish than expected because the term "extended period" was used again when describing the appropriateness of the current neutral policy stance. Therefore, the probability of policy tightening at the next MAS meeting in October remains an outside risk rather than a central scenario for now. There was an initial boost to USDSGD FX swaps (implying higher SORs) when the statement was released. However, intraday gains could not be sustained and FX swaps and SORs have been grinding lower in the days after the MAS event. Post event, SGD NEER has remained sticky on the strong half of the policy band despite an "extended" neutral policy stance and this resilience has helped to cap the upside potential in SORs. Implications from the MAS policy stance has also been blunted by external factors related to investor disillusionment with the US reflation narrative. Over the past month, USD sentiments have declined and Emerging markets (EM) inflows have picked up as liquidity sought out yield and carry trades while volatility remains suppressed. Such inflows have added pressure on the USDSGD FX swaps and thereby kept SORs contained. Looking ahead, mean reversion tendencies in SGD NEER will be thwarted if EM inflows persists thus in this scenario we can expect SORs to have limited upside. However, the correlation divergence between EM and the commodity complex will have to resolve in favour of the former in order to give more comfort to persistence in SGD NEER strength. Money market curves flatter Over the past month, money market rates (Libor, Sibor and Sor) have been fairly well behaved as fixing volatility remained low and short horizon volatility continued to trail longer dated norms. 3M US Libor plateaued at around 1.15 since the middle of March due to the absence of a FOMC meeting in April, but has ticked higher in the last week of April and will likely continue doing so to price in FED hike expectations for the June FOMC. Implied probabilities of a June FED hike was under pressure in the first half of April due to a combination of heightened geopolitical uncertainty and a soft patch in economic data. But risk appetite and investors optimism returned in the second half to take rate hike expectations above where it started the month. However, confidence in the FED being able to see through a full hike cycle was less quick to bounce back compared to expectations for June FOMC as can be seen with the Eurodollar futures curve remaining flatter compared to where it started April. SOR and SIBOR 1M vs. 6M curves flattened by 2 and 6 between end March to end April which was consistent with US Libor trend, though it should be noted that the latter has begun to steepen from the middle of April. US Libors are likely to resume their grind higher in May unless FED hike expectations encounter a significant negative shock. Higher Libors will in turn help to bolster the floor in SORs assuming that domestic inflows do not pick up significantly in May.
Probability of June FED Hike Eurodollar futures 4th vs. 8th 75 70 65 60 55 50 45 40 3-Apr 8-Apr 13-Apr 18-Apr 23-Apr 28-Apr 0.42 0.40 0.38 0.36 0.34 0.32 0.30 3-Apr 8-Apr 13-Apr 18-Apr 23-Apr 28-Apr In a nutshell SORs will struggle to reprice significantly higher when the environment favours yield seeking behaviour amidst suppressed volatility. That said the bar has been set fairly low for the reflation narrative to cross, thus it remains to be seen SGD NEER can continue to resist mean reversion when the tide turns back in favour of developed markets. SORs short term outlook * SGD NEER stickiness on the strong side a reflection of better EM sentiments and disillusionment with reflation narrative. Persistence will cap the upside potential on SOR * FED hike implied probabilities repricing potential could start to pick up in May, i.e. US Libors resume their grind higher to price in June hike risk. * Range for 3M SOR: 0.90 to 1.00 SORs Long Term Outlook * Base case sees FED hiking twice more (50) in 2017. MAS risk is tilted towards possible tightening at October's meeting. * US Libors to be the primary directional signpost for SORs. USDSGD currency trends remains a driver but impact on SORs more muted compared to 2014/2015. Base case does not see idiosyncratic richening of SG risk premium. Forecasts 2Q 2017 3Q 2017 4Q 2017 1Q 2018 3M USD LIBOR 1.55 1.80 1.85 5 3M SOR 1.15 1.35 1.40 1.60 3M SIBOR 1.40 1.45 1.65 2 P a g e
Singapore Government Securities (SGS) and Interest Rate Swaps (IRS) Post mortem of August 2036 (NZ16100X) 20Y mini auction SGD 800 mio was auctioned at 2.39 cut off which was closer to where the interbank market was offering ahead of the auction. Demand for 20Y was similarly strong with a bid to cover of 2.16 times which surpassed last October's 30Y mini auction where demand was an already robust 1.98 times. The 20Y auction result will reduce the immediate needs to push for concession ahead of next month's 30Y regular auction. SGS outperformance potential vs UST will also benefit at the margin and this should help to cushion any correlated re-pricing if the 10Y UST was to reclaim the previous higher yield range of 2.30/2.50 in May. August 2036 has cheapened by 8 on the asset swap curve (ASW) between the start of April till mini auction day. Based on the robust mini auction results, we will expect some limited richening as the path of least resistance for the first half of May. Acting as offset against a deeper richening move will be the upcoming 30Y auction. Good results from the 20Y notwithstanding, the prevailing 30Y SGS yield is low when regressed against 10Y UST yield going back to 2011. Look ahead at 30Y (NA16100H) re-open auction in May A good 20Y mini auction in April does muddy the waters somewhat for concession building ahead of May's 30Y regular auction. Good demand evidenced on the 20Y will likely be extrapolated to the 30Y since the latter has strong tendencies to trade special. The result is a 20s30s SGS curve that more often then not trades in single digits (6 as of 26 April). Long end SGS steepeners may struggle to repeat previous dynamics heading into the 30Y auction if investors adopt a short term bias to buy into dips/short cover due to a good 20Y mini auction. That being said, 10s30s SGS steepeners remains our auction bias even if the upside potential is diminished since significant curve flattening continues to be an outlier risk and because the steepener carries positive. As mentioned in the 20Y mini auction post mortem section, outright yields are low compared to 10Y UST yield. Even though investors appear to be more comfortable with duration risk as can be seen from speculative non-commercial 10Y UST positions turning long for the first time since October 2016 on 18 April. There is still significant duration at risk from 30Y SGS supply to argue against complacency. 10Y UST could reclaim the 2.30/2.50 range with a fraction of the reflationary fervour observed back in November/December 2016 and the resulting re-pricing in SG rates markets could turn volatile especially when valuations are on the rich end of history. An alternatives to the 10s30s steepener worth considering will be a 10Y bondswap widener which will benefit from a scenario of SGS short covering and higher 10Y UST yields while also gaining from spill over hedging flows related to the 30Y auction. Higher rates view hitting speed bumps SG yields have tumbled since the middle of March, 10Y SG IRS touched an intraday high of 2.76 on 14 March and closed at 2.39 on 26 April, due to a confluence of factors that caused investors to become less enamoured with the previously dominant US led reflationary theme. These factors include evidence of US political gridlock; geopolitical concerns and a shift in positive economic data surprise away from the US towards Asia have combined to create a favourable environment for yield seeking behaviour. 10Y UST breaking the 2.30 yield support was the inflection point which has driven short term price action. Indeed, speculative short positions have been pared back sharply and have flipped long as of 18 April. Decomposing the 10Y UST performance into real rates vs inflation expectations, we can see that both factors have taken a hit. US political gridlock and a softer patch in US economic data has led investors to lower their expectations of the FED being able to carry out rate normalization in a timely fashion which dragged real yields lower. On the inflation front, expectations have also moderated but are kept supported whilst oil prices remain range bound. Risk aversion, as proxied by USDJPY, due to increased geopolitical uncertainty has also coincided with 10Y UST term premiums turning negative. 3 P a g e
Eurodollar Futures curve 10Y US Real Rates Crude Oil (lhs) Inflation Expectations (rhs) 1.2 120 3.3 1.0 0.8 0.6 0.4 0.2 100 80 60 40 20 2.8 2.3 1.8 1.3-0.2 18-Apr 18-Jul 18-Oct 18-Jan 18-Apr 0 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 0.8 The above mentioned has resulted in consensus estimates for yield forecasts being lowered across the board, for example median analyst expectation between March and April surveys now sees 10Y UST targets at the end of 2017 lower by 5 from 2.90 to 2.85. A majority continues to call for an upward trajectory in yields within the forecast time horizon which is also our expectation. Factors favouring higher yields remain valid (more a question of when rather than if) such as fiscal stimulus and deficit implications as well as FED rate hikes and balance sheet run down implications. Negative 10Y UST term premiums compare poorly when investors' focus shifts back onto the questions of deficit and FED balance sheet adjustment. We can look back to 2013's taper tantrum for a sense of the scale of repricing that can occur in the 10Y UST term premium when the market is presented with a negative shock. At that time, 10Y UST term premium spiked by 144 in merely 76 days and eventually topped out in December 2013 for a total of 162 trough to peak gains, which ought to be enough incentive to guard against complacency this time round. JPY (lhs) 10Y US Term Premium (rhs) 10Y UST Term Premium - 2013 120 115 110 105 100 95 18-Apr 18-Jul 18-Oct 18-Jan 0.4 0.2-0.2-0.4-0.6-0.8-1.0 0 1.80 1.80 1.60 1.40 1.00 0.40 0.20 0.18 0 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 10Y SGS (constant maturity) short term outlook * Yield searching for a base to define the next range. * Episodic underperformance vs. UST likely related to 30Y SGS supply. * A test of 2 (full Trump reset) remains a possibility should risk aversion spike significantly. 4 P a g e
10Y SGS (constant maturity) long term outlook * Directional bias for higher yield over the course of 2017. Yield overshoot potential is better within the first half of 2017, driven primarily by details of US fiscal stimulus policies. * Base case sees regional economies weathering the storm of reflation. SG risk premium not expected to richen idiosyncratically. Potential for SG yields to slide under US yields. Forecasts 2Q 2017 3Q 2017 4Q 2017 1Q 2018 10Y UST 2.75 2.80 3.00 3.00 10Y SGS 2.65 2.70 2.80 2.80 5 P a g e
Appendix SIBOR SIBOR: Monthly Change 3M SIBOR - 12 months to 27 Apr 2017 7.0 6.0 5.0 4.0 3.0 1.0 1M 3M 6M 12M 1.10 1.00 0.90 3M SIBOR -1SD AVE +1SD SOR SOR: Monthly Change 3M SOR - 12 months to 27 Apr 2017 - -4.0-6.0-8.0-1 Overnight 1M 3M 6M 1.35 1.15 0.95 0.75 0.55 0.35 3M SOR -1SD AVE +1SD BILLS Indicator Date 3M 6M 12M 27 Apr 2017 0.96200 0.99400 1.05100 Bills 27 Mar 2017 0.92100 0.97300 1.02900 Bills: Monthly Change 3M Bills - 12 months to 27 Apr 2017 5.0 4.0 3.0 1.0 3M 6M 12M 1.00 3M Bills -1SD AVE +1SD Tuesday, 28 February 2017 6 P a g e
SGS Indicator Date 2Y 5Y 10Y 15Y 20Y 30Y 27 Apr 2017 1.193 1.619 2.145 2.306 2.380 2.422 SGS 27 Mar 2017 1.175 1.555 2.177 2.322 2.380 2.414 SGS: Monthly Change 2Yx10Y SGS - 12 months to 27 Apr 2017 8.0 6.0 4.0 - -4.0 2Y 5Y 10Y 15Y 20Y 30Y 1.40 1.00 2Yx10Y SGS -1SD AVE +1SD IRS Indicator Date 2Y 5Y 10Y 15Y 20Y 30Y 27 Apr 2017 1.438 1.938 2.375 2.533 2.608 2.657 IRS 27 Mar 2017 1.490 05 2.450 2.640 2.730 2.783 IRS: Monthly Change 2Yx10Y IRS - 12 months to 27 Apr 2017 - -4.0-6.0-8.0-1 -1-14.0 2Y 5Y 10Y 15Y 20Y 30Y 1.40 1.00 0.40 2Yx10Y IRS -1SD AVE +1SD Disclaimer: This analysis is based on information available to the public. Although the information contained herein is believed to be reliable, UOB Group makes no representation as to the accuracy or completeness. Also, opinions and predictions contained herein reflect our opinion as of date of the analysis and are subject to change without notice. UOB Group may have positions in, and may effect transactions in, currencies and financial products mentioned herein. Prior to entering into any proposed transaction, without reliance upon UOB Group or its affiliates, the reader should determine, the economic risks and merits, as well as the legal, tax and accounting characterizations and consequences, of the transaction and that the reader is able to assume these risks. This document and its contents are proprietary information and products of UOB Group and may not be reproduced or otherwise. Singapore Company Reg No. 193500026Z