Bund underperformance; ST SGD rates drift lower; Chilean peso not stirred by protests

Further Bund underperformance ahead. The Sibor looks elevated. Chilean protests hit peso.
Duncan Tan, Eugene Leow, Philip Wee22 Oct 2019
    Photo credit: AFP Photo

    Rates: Bund underperformance likely to extend
    Despite more weakness in German and Eurozone economic data, German Bunds have significantly underperformed their US and Japanese counterparts. Since ECB’s September meeting, 2Y and 10Y Bunds yields have climbed 18-19bps. Several factors could be at play here. Diversity of views within the Governing Council, particularly with some governors questioning the case for QE resumption, has likely reduced expectations of incremental monetary stimulus ahead. Markets' pushback against deeply negative Bund yields might also be building. Some investors could be incentivized to sell out of Bunds, where they are guaranteed to make a loss if held to maturity, and allocate to positive yields in US and EM. Some European banks could be better off parking liquidity at the ECB at lower cost, compared to holding Bunds.

    We continue to hold the view that sovereign spreads over Bunds (eg. Spain-Germany) can compress further. However, instead of spreads tightening due to QE pricing (ie Spain yields fall against German), it is now more likely that we see Bunds underperform and spreads tighten. ECB's inaction on QE technical constraints and the German government's reluctance to deploy fiscal stimulus and issue more Bunds could support our view. To stay within 33% issue/issuer limits, future bond purchases by ECB could be increasingly skewed away from Bunds and towards other sovereigns.
    We also note that the Bund curve (10-2Y segment) did not follow UST and JGB's recent steepening. This seems to be driven by the front-end which is pricing for short-term EUR rates to rise on the back of ECB's introduction of reserves tiering. In the next few meetings, if ECB increases the exempt tier (currently, 6x minimum reserve requirement) and/or refrains from cutting the deposit rate further, prospects of much higher short-term rates would exert more flattening pressures on the Bund curve.

    Rates:  ST SGD rates have drifted lower            
    An improvement in SGD liquidity and the pullback in USD strength have generally put downward pressure on short-term SGD rates. Since end-September, the fx-implied 3M SOR and the 3M MAS bill rates are down by 12bps and 26bps respectively. Similarly, the SORA (set to be the new SGD risk-free rate) fell by 26bps. Only the 3M Sibor was broadly unchanged over the same period, hovering around 1.87%. At current levels, we think that the SOR, bill rates and SORA are probably appropriate relative to USD rates and there may not be much scope for further outperformance. We are of the view that the 3M Sibor is still somewhat high, possibly reflecting the tighter financing conditions faced by banks. In any case, the spread of the 3M Sibor over the 3M SOR looks stretched (1.7 standard deviations from the 5Y mean) and we think that an adjustment is in the offing. 

    FX: Shaken not stirred by Chilean protests

    The Chilean peso depreciated 2.1% on Monday against the USD. The S&P/CLX IPSA stock index plunged 4.6% on high volume. Although President Sebastian Pinera’s announced last Saturday that the unpopular subway hike would be cancelled, violent protests continued into Sunday and Monday, and resulted in deaths from looting and vandalism. According to at-the-money implied volatility for USDCLP, this was still viewed as a short-term stress. While 1M volatility increased to 10.30% on Monday from 9.12% last Friday, the rise in 6M was milder to 9.87% from 9.30%. Nonetheless, investors in Emerging Markets will be keeping close tabs here. Chile is considered one of Latin America’s more stable countries, both economically and politically.

    Duncan Tan

    FX and Rates Strategist - Asean


    Eugene Leow

    Rates Strategist - G3 & Asia


    Philip Wee

    FX Strategist - G3 & Asia


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