Credit: Get paid to take less risk
- Amid the challenging investment landscape, investors would find refuge in IG credit
- Projections of cash deposit rates are unlikely to outperform IG credit in the medium term
- This is despite the aggressive pace of rate hikes
- History may repeat itself in this hiking cycle and yields remain below prior peaks
- IG credit stands to see capital gains amid repricing of the interest rate environment lower
Income certainty comes at a discount. The investing world has found no shortage of risks in 2022, with the largest commodity moves in a decade, unabating geopolitical tensions around the Russia-Ukraine crisis, widespread volatility around risk assets, and the first 50 bps Fed hike in 22 years. Yet the price for income certainty has scarcely been as reasonable as it has become, with global Investment Grade (IG) yields at c.3.8% – a level not seen in the last 10 years, exceeding even the peak of the Covid-19 crisis.
The false allure of cash. Undeniably, with financial markets seeing sharp declines, it is natural for risk-averse investors to seek the safety of cash. Yet the prospect of facing the highest inflation in 40 years leaves it difficult to imagine that cash would register positive real returns in the medium term. Those who are banking on interest rate hikes to increase the returns of cash may find themselves disappointed on two accounts:
- Ever-lower peak interest rates. Despite the aggressiveness by which the Fed had projected the path of interest rates, history has shown that each subsequent peak in the hiking cycle had always been lower than the last, owing to the secular decline of the long-term neutral rate of interest from (a) ageing demographics, (b) high global debt burdens, and (c) technological disruption leading to a productivity boom. This time may not be different.
- Low terminal rates. Even with the current hawkish estimates, the Federal Open Market Committee (FOMC) median peak rate is presently 2.75%, while the Fed funds futures peak pricing is c.3%, lower than the yield on IG credit. With historically low default rates in high quality credit, there is a high likelihood that IG would outperform cash through this hiking cycle.
Unanticipated upside. We see the asymmetry in outcomes benefiting investors who switch from cash to IG credit. Firstly, should rate hikes proceed as anticipated, investors would still obtain a return on IG credit that exceeds the anticipated higher cash deposit rates. By our estimates, the Fed needs to price in hikes that are c.1% higher than current estimates before cash would outperform IG over a five-year horizon. Secondly, should history repeat itself and the Fed find themselves unable to hike as aggressively as expected, the yields on short-term bonds would reprice lower and result in capital gains for high quality credit. We view this risk-reward advantageous for investors to deploy cash into short-dated (3-5 year duration), high quality credit – capitalising on the certainty of income generation while most other risk assets grapple with volatility.
Download the PDF to read the report.
DISCLAIMERS AND IMPORTANT NOTES
This information herein is published by DBS Bank Ltd. (“DBS Bank”) and is for information only. This publication is intended for DBS Bank and its subsidiaries or affiliates (collectively “DBS”) and clients to whom it has been delivered and may not be reproduced, transmitted or communicated to any other person without the prior written permission of DBS Bank.
This publication is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to you to subscribe to or to enter into any transaction as described, nor is it calculated to invite or permit the making of offers to the public to subscribe to or enter into any transaction for cash or other consideration and should not be viewed as such.
The information herein may be incomplete or condensed and it may not include a number of terms and provisions nor does it identify or define all or any of the risks associated to any actual transaction. Any terms, conditions and opinions contained herein may have been obtained from various sources and neither DBS nor any of their respective directors or employees (collectively the “DBS Group”) make any warranty, expressed or implied, as to its accuracy or completeness and thus assume no responsibility of it. The information herein may be subject to further revision, verification and updating and DBS Group undertakes no responsibility thereof.
All figures and amounts stated are for illustration purposes only and shall not bind DBS Group. This publication does not have regard to the specific investment objectives, financial situation or particular needs of any specific person. Before entering into any transaction to purchase any product mentioned in this publication, you should take steps to ensure that you understand the transaction and has made an independent assessment of the appropriateness of the transaction in light of your own objectives and circumstances. In particular, you should read all the relevant documentation pertaining to the product and may wish to seek advice from a financial or other professional adviser or make such independent investigations as you consider necessary or appropriate for such purposes. If you choose not to do so, you should consider carefully whether any product mentioned in this publication is suitable for you. DBS Group does not act as an adviser and assumes no fiduciary responsibility or liability for any consequences, financial or otherwise, arising from any arrangement or entrance into any transaction in reliance on the information contained herein. In order to build your own independent analysis of any transaction and its consequences, you should consult your own independent financial, accounting, tax, legal or other competent professional advisors as you deem appropriate to ensure that any assessment you make is suitable for you in light of your own financial, accounting, tax, and legal constraints and objectives without relying in any way on DBS Group or any position which DBS Group might have expressed in this document or orally to you in the discussion.
Any information relating to past performance, or any future forecast based on past performance or other assumptions, is not necessarily a reliable indicator of future results.
If this publication has been distributed by electronic transmission, such as e-mail, then such transmission cannot be guaranteed to be secure or error-free as information could be intercepted, corrupted, lost, destroyed, arrive late or incomplete, or contain viruses. The sender therefore does not accept liability for any errors or omissions in the contents of the Information, which may arise as a result of electronic transmission. If verification is required, please request for a hard-copy version.
This publication is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.
If you have received this communication by email, please do not distribute or copy this email. If you believe that you have received this e-mail in error, please inform the sender or contact us immediately. DBS Group reserves the right to monitor and record electronic and telephone communications made by or to its personnel for regulatory or operational purposes. The security, accuracy and timeliness of electronic communications cannot be assured.
Singapore: This publication is distributed by DBS Bank Ltd (Company Regn. No. 196800306E) (“DBS”) which is an Exempt Financial Adviser as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore (the “MAS”).
Indonesia: This publication is distributed by PT Bank DBS Indonesia (DBSI). DBSI is licensed and supervised by the Indonesia Financial Services Authority (OJK) and a member of the Indonesia Deposit Insurance Corporation (LPS). This publication is not and does not constitute or form part of any offer, recommendation, invitation, or solicitation to you to subscribe to or to enter into any transaction as described, nor is it calculated to invite or permit the making of offers to the public to subscribe to or enter into any transaction for cash or other consideration and should not be viewed as such.
India: This publication is distributed by DBS Bank India Ltd. (“DBIL”) and is on “as is” basis and for information only. This publication is not intended to be source of advice in respect of the material presented or information published, and shall not be construed to be legal, tax, financial or investment advisory. This document is not, and should not be construed as, an offer, invitation, recommendation, or solicitation to enter into any transaction in relation to any of the products and services mentioned herein. DBIL does not make any warranty of any kind, express or implied, including but not limited to warranties of completeness, accuracy of information, merchantability, or fitness for a particular purpose.