Fixed Income Weekly: Financial Stability Worries to Upend Fed's Hawkish Stance
- Financial stability concerns over failure of US regional banks could curb hawkish Fed
- Investors contend with potential fallout; credit spreads widen across major bond markets
- Two new issues by HSBC PLC and Sembcorp Financial in SGD primary market
- Widening credit spread for banks' capital securities a compelling entry point for income investors
FOCUS OF THE WEEK
Financial stability concerns to curb overly hawkish Fed. Taken in isolation, the latest inflation figures (CPI: 0.4% m/m, core CPI: 0.5% m/m) and strong non-farm payrolls (311k) from last week would have cemented a 50 bps hike. A breakdown of the various measures suggests that CPI momentum is running at about 4% (or a tad higher) on a three-month annualised basis. In particular, the services ex-energy component is still hot at around 6.2%. In short, inflation is still uncomfortably hot.
However, with fears of potential contagion stemming from the failures of several regional US banks, stability concerns will be top of mind when the Fed meets next week. This underscores why we have generally been reluctant to push for a much higher terminal rate from what the Fed guided in December. Having had this much tightening already delivered and rates already in restrictive territory, the risk of something "breaking" in the system is high and has been high for a while.
We still see two more hikes in this cycle taking the terminal rate to 5.25%. This is contingent on no further fallout/shocks to the system. Jitters are definitely abound with swings in 2Y yields even more extreme than those seen in 2022. Implied volatility in rates and financial conditions are as bad or worse than the most acute points last year as a combination of late cycle worries, financial system stress, and a hawkish Fed clash. We prefer to stay the middle ground, noting that stresses look contained for now, and this would eventually allow the Fed to refocus on its dual mandate. However, the tail risk of an overly aggressive Fed is probably gone.
US inflation momentum, sticky services inflation
Source: Bloomberg, DBS
MARKET ACTIVITY & PIPELINE OBSERVATIONS
Asia ex-Japan USD Primary Market
Asia ex-Japan USD primary market saw muted supply with just one public deal as issuers and investors were keenly looking at the important jobs number. Just Bank of East Asia came to the public markets in the last week, printing a USD500m 4NC3 trade.
Asia USD credit market started the week (ending 10 March) firm helped by (1) a positive tone following equity markets closing in the green the previous Friday (3 March), as well as (2) retracement in the US Treasuries selloff. Activities were mainly focused on the newer issues with better buying in the KBANK 28s. The Sumitomo new bonds which initially saw some flippers also traded up in the early part of the week. Korean bonds also saw better buyers with the KDB 28s up to 59 on Monday. Chinese tech names also opened the week on the front foot. Indian IG names ended on Monday 2-3 bps tighter.
However, credit drifted wider following Powell’s testimony which was delivered in a hawkish manner and where certain members were supportive of a 50 bps hike in the next Fed meeting. Following the big moves in rates overnight following this, credit markets opened weaker. Asian IG started on the backfoot and widened 7-8bps. HAOHUA 30 opened down +205 bp, traded up to +200 bps before being hit down again to +202 bps, +203 bps. Similarly for benchmark tech, TENCNT 30 opened down +160 bps, bottom fishers soon emerged to lift it back up to +157 bps before better sellers during the London hour and took it back down to +160 bps.
Overall, Asia secondary investment grade (IG) indices traded c.13 bps wider with Asia iTraxx at 125 bps (c.13 bps wider w/w. Asia secondary HY indices were also c.14 bps wider with Barclays Asia HY at 13.29% (c.14 bps wider w/w).
Global financials: Demise of SVB an outlier with modest implications for larger and more diversified banks’ credit profiles
- Credit spread widening for banks' capital securities last week on the back of SVB’s demise provides a compelling entry point for income investors.
- While the SVB situation was unique, a consequence is that growth expectations in profitability for the banks this year and next will reduce, as higher funding costs emerge. However, banks’ credit profiles are expected to remain generally steady with capital buffers remaining high relative to the last decade.
- While we are less concerned about banks' unrealised mark-to-market losses on investment portfolios, we think that commercial real estate is an area to watch. We regard this as most pronounced for banks in China and the Nordic region within our coverage universe.
- Our preference remains towards larger, higher-rated banks globally that are repeat issuers in fixed income markets.
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