Asia Rates: Impact from rising energy prices


Elevated and rising oil and energy prices constitute a significant headwind for Asia interest rates and Asia sovereign bond total returns.
Group Research28 Oct 2021
  • Countries with larger oil and energy trade deficits and…
  • …bigger passthrough risks to domestic inflation are seeing their interest rates rise more.
  • The size and pace of increase in oil prices is a more important factor than the level of prices.
  • INR rates exhibit the highest sensitivities to fluctuations in oil prices.
  • Implications for investors: Initiate Pay 5Y vs Receive 1Y INR NDOIS (steepener).
Photo credit: AFP Photo


Energy prices are a key variable in Emerging Markets. Fluctuations in energy prices have a direct impact on trade and current account balances and will also passthrough, to varying degrees, onto domestic inflation and inflation expectations. Many countries in Asia are net oil importers, and thus their exposures to oil prices are mostly negative (benefit from lower rather than higher oil prices). Malaysia is a notable exception with a net oil trade surplus (net oil exporter). Indonesia, due to its exports of other commodities such as coal, CPO and gas (prices tend to be correlated to oil), enjoys some extent of buffer/hedge against higher oil prices.

Though higher oil prices are generally a headwind for Asia, the nature of underlying drivers matters. If higher oil prices largely reflect strong global growth and demand, then there would be offsetting benefits on Asian exports. A more positive global outlook would also be supportive of risk sentiments and tend to drive tightening of risk premium in higher-beta Asia bonds such as IndoGBs. On the other hand, if the underlying drivers are more cost-push/supply-driven (as in the current context), then higher oil prices would not only drive higher inflation, but also weigh on demand and growth via higher input costs.

When we compare relative moves across Asia interest rates, we see clear differentiation based on each respective countries' exposures to oil and energy prices. Countries with larger oil and energy trade deficits and bigger passthrough risks to domestic inflation are seeing their interest rates rise more. The degree of passthrough risks can vary across Asian countries, depending on the presence of energy subsidies, oil-related weights in CPI baskets, central banks' inflation-targeting credibility etc.



In terms of impact on Asia interest rates, we think that the size and pace of increase in oil prices is a more significant factor than the level of oil prices. This is because the primary mode of oil impact is via passthrough to higher inflation and inflation expectations that would be priced into rate hike expectations. To measure the sensitivities of Asia interest rates against fluctuations in oil prices, we regress weekly changes in 5Y swap rates against weekly changes in Brent price, over the last 10 years.

Across the entire sample period (red bars), we find that INR rates exhibits the largest beta to Brent price, rising 0.8bps for every $1 increase in Brent price. The betas of THB, KRW, MYR, PHP and CNH rates are quite close to one another, between 0.3 and 0.4. IDR rates (we substituted with IndoGB yields due to illiquidity of IDR swap markets) is the one outlier with a negative beta. I.e. IndoGB yields tend to decline when Brent price rise, primarily due to compression of risk premium mentioned above.

When we split our sample into high-price (Brent >$60) and low-price (Brent <$60) ranges, we find that Asia interest rates generally exhibit larger betas at higher Brent prices (CNH rates a outlier). This holds true even as a $1 change in Brent price is worth less in percentage terms in a high-price regime. The asymmetry likely points to greater risks of un-anchoring of inflation expectations at higher oil price ranges.



Asia interest rates also generally exhibit larger betas when the absolute change in Brent price is larger (PHP rates a outlier). I.e. Larger changes in Brent price could be more likely to trigger repricing of inflation expectations.



Between weekly increases and declines in Brent prices, we find that beta sensitivities of 5Y Asia swaps are symmetrical in either direction.

At present, underlying cost-push factors are likely outweighing demand-pull factors in supporting oil and energy prices. And some of these supply-related drivers are not likely to ease in the near term. Therefore, in the current context, we think that elevated and rising oil and energy prices are unambiguously a headwind for Asia interest rates and negative for Asia sovereign bond total returns. In the current high-price and high-vol oil regime, applying our observations above, we would also expect Asia interest rates to be volatile and highly sensitive to fluctuations in oil prices.

Within the Asia interest rates space, our strategy favours going underweight India/Thailand/Korea/Philippines sovereign bonds (negative exposures to oil and energy) vs overweight Indonesia/Malaysia bonds (positive or less negative exposures to oil and energy).

Considering the beta sensitivities of respective Asian swap markets, the best expression of the view that oil and energy prices are likely to stay elevated is via INR swap rates. In our recent report INR Rates: Greater normalization impetus, we had favored bond-swap spread tighteners - Long 10Y IGB vs pay 5Y INR NDOIS, to leverage on swaps' greater beta sensitivity to rising oil prices and rate cycle expectations. However, markets have moved quickly on that spread and current levels may not be attractive to enter. We therefore switch and express via initiating a Pay 5Y vs Receive 1Y INR NDOIS (steepener) at entry 1.26%, stop-loss 1.05% and take-profit 1.55%. The 5Y-1Y INR NDOIS spread tends to track oil prices well and is carry-friendly. We also expect the 1Y to be better anchored by RBI's accommodative stance while elevated oil prices would put disproportionately more upward pressures on the 5Y.

Report Links - 23-Mar-21  30-Mar-21  03-May-21  06-May-21  19-May-21  18-Jun-21  7-Jul-21  2-Sep-21  30-Sep-21
 

To read the full report, click here to Download the PDF.
 

Duncan Tan

Rates Strategist - Asia
duncantan@dbs.com

Eugene Leow

Senior Rates Strategist - G3 & Asia
eugeneleow@dbs.com

Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.

The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation.  Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.  The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation.  The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.

This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.

DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. 

DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability.  18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.

DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability.  13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR

Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply.  The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.