Fixed Income Weekly: Fed Divided on Further Hikes as Debt Ceiling Concerns Drag
FOCUS OF THE WEEK
USD Rates: Skip or pause? The front of the USD curve continues to reprice and is now entertaining the possibility of a Fed skip in June. This is a relatively new development, with the market only very recently assigning a higher probability of a July hike (37%) compared to a June hike (20%). Note that the front of the USD curve has been volatile in recent weeks. Between pricing in the risks of a banking crisis (odds of a June cut) just a few weeks ago to factoring in a pause and now into a skip, expectations have proven to be very fluid.
The arguments for a skip are as follows. Inflation still looks sticky, but the Fed might want more time to assess the impact of the hikes already delivered. Accordingly, keeping the option open for further hikes might make sense. Note that the Reserve Bank of Australia already delivered a skip, and this is a plausible scenario for the Fed if certain conditions come into play (very firm economic indicators and limited financial market stress). However, this makes forecasting the terminal Fed rate much more difficult as the string of hikes would be broken. A skip is not our base case.
The key question lies with whether the Fed would be satisfied with cooling inflation or if the labour market must show meaningful cracks before the Fed is willing to cement a pause. Aside from data, we would also be mindful of financial conditions. When yields go up too swiftly, there tend to be stresses on the market. Thus far, markets have been calm as yield levels are not quite close to levels seen in early March (before the collapse of regional lenders). Rate pricing out through this year is more reasonable now, factoring in about 1.5 cuts from current levels. We reckon that the market will want to protect against some downside risks (such as commercial real estate and the banking sector) and keep some rate cut pricing in. These might fade in time, but it is still probably too early to conclude that the US economy will be fine out to the end of the year.
Credit spread movements. While investors await further clarity regarding the Fed’s next course of action, and the US debt ceiling negotiations, the past week (ended 19 May) saw contraction in credit spreads across all major bond indices, with weekly tightening notably observed in high yield bonds and AT1s.
Changes in Spreads
Source: Bloomberg, DBS
MARKET ACTIVITY & PIPELINE OBSERVATIONS
Asia ex-Japan USD Primary Market
Asia ex-Japan USD primary market activity remained constructive with a total of USD1.6b printed across four transactions in the week ended 19 May. In a data-light week where the market window was generally clear, investment grade (IG) issuers across Singapore, China, and Korea were able to complete USD benchmark transactions with reasonable new issue concessions.
Another positive week (ended 19 May) for Asia IG with constructive flows. Chinese TMT saw overall tightening in spreads as we entered earnings season. Baidu and Tencent reported revenue growth off the back of China’s strong consumption recovery. TENCNT 30 tightened c.4 bps and BIDU saw good two-way flows. On the other hand, Alibaba’s result miss weighed on overall sentiment, causing its bonds to trade in a tight range.
In the SOE space, spreads remained firm. High-beta HAOHUA’s curve tightened c.6 bps as Syngenta’s statement to move forward with its IPO plan pursuing main board listing at the Shanghai Stock Exchange fuelled hopes of ChemChina’s faster deleverage. In the HK space, the new CKHH and other strong IG corporates (e.g., SUNHUN, HKLSP, SWIRE), continued to see buying interest. NWDEVL saw bottom fishing from retail accounts, with perps up c.3pts.
The SGD credit market opened firm with healthy two-way flows led by both retail and real money accounts. There were active sessions in financial T2s across a wide spectrum of names such as Aussie and European banks, and insurance names. Overall, better buying interest was seen from retail accounts, while institutional accounts took the chance to lighten up on recent financial prints. For non-financials, activity was evenly split between crossover and TLC/IG names.
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