Fixed Income Weekly: Markets Assess Damage in Bank Failure Aftermath
FOCUS OF THE WEEK
USD Rates: Back from the brink. USD rates are finally paring acute fears of a banking crisis. 2Y yields have climbed back into the lower bound of the 4-4.5% range while 10Y yields are now comfortably above 3.5%. This week (ending 31 March) marked near-term capitulation in the banking sector turmoil. With sentiment stabilising for now, we look at a breakdown of USD rates to examine what is being priced in, and how these fit into stressed financial conditions.
Firstly, the Fed path pricing has swung from one extreme to another. At the worst of the crisis, the market was pricing >200 bps of cuts by end-2024. There is now no longer conviction of further hikes, and cuts priced to end-2024 have fallen to 164 bps, with further to go if sentiment stays stable. Secondly, inflation expectations (10Y breakeven) have rebounded to 2.30%. Moves in the long end have been muted. Overall, breakevens appear low, but if the Fed were to place greater emphasis on financial stability, there could be scope for breakevens to climb, driving long-end rates up. Finally, we think term premium is neutral. Extreme pricing of stagflation (inverted curves) has faded.
If sentiment stabilises, the Fed will toe the line between financial stability and inflation. This will mean limited room for a higher terminal rate than what is already guided. Instead, the bias would be to assess the economic damage, keep rates steady for some time before guiding policy settings back towards neutral when inflation comes under control.
Breakdown of changes in 10Y UST yield
Source: Bloomberg, DBS
MARKET ACTIVITY & PIPELINE OBSERVATIONS
Asia ex-Japan USD Primary Market
Asia ex-Japan USD primary market was muted as the market was subdued amid worries over the health of financial institutions, presenting a challenging funding environment for issuers contemplating tapping the USD market. Primary supply for the week ending 24 March came from Philippine real estate company DoubleDragon, which priced a small-sized USD20m tap on its existing 5NC3 senior notes, bringing the total size to USD180m. The CNH market saw decent supply with activities mostly coming from the FTZ bond issuance. Notably, BOC issued a 2Y CNH1b sustainability bond at 2.98%, and the book was mainly driven by Chinese banks’ orders and demand from real money accounts.
Asia USD credit market was volatile with a wave of panic-selling in AT1s to start the week ending 24 March. European AT1s had the most substantial impact at c.10-15 pts down. Singapore and Chinese AT1s were down 2-4 pts, Thai AT1s down 5 pts, and HK AT1s down 10 pts with BNKEA Perps being one of the most beaten down. Sentiment was grim although markets were calmed by European regulators reiterating that AT1 bonds shall only take losses after contributors of common equity Tier 1 such as shareholders are wiped out. Following the statement, we saw quick recovery of AT1 levels across the platform, with support from dip buyers.
In the broader IG space, risk-off sentiment at the beginning of the week saw muted activity but flows picked up post-FOMC. Benchmark TMT names like BABA and TENCNT rallied 5-8 bps before profit takers emerged to reduce risks. In the China HY space, China Evergrande unveiled its restructuring proposal and appears to have reached an agreement with its larger offshore debt holders to term out its existing bonds by 10-12 years with an equity-linked option. Against this news, we saw TIANHL 11.5 22 trade higher by 2-3 pts on the street.
Overall, Asia secondary IG indices traded c.6 to 13 bps wider with Asia iTraxx at 149 bps (c.13 bps wider w/w), Barclays Asia IG Aggregate (spread) at 148 bps (c.6 bps wider w/w). Asia secondary HY indices were 60 bps wider with Barclays Asia HY (yield) at 14.36% (c.60 bps wider w/w).
Cautiously optimistic on Singapore office outlook
- Limited new Grade A supply in core CBD remains supportive of rents but rental growth likely to taper off as economic headwinds persist.
- Office REITs with diversified revenue streams from other sectors (retail, hospitality) to benefit from the China reopening and tourism recovery play.
- We prefer an office portfolio tilt towards Singapore assets to minimise the impact of overseas office cap rate expansion.
- Most of the office REITs have some buffer against higher refinancing cost on the back of high fixed rate debt proportion and manageable short-term debt maturity.
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