04 October 2023
“September FOMC delivered a hawkish hold indicating greater confidence in rates staying higher for longer”
Fixed Income Macro
Yields are climbing to new cycle highs as the September FOMC delivered a hawkish hold indicating greater confidence in rates staying higher for longer on growth prospects improving and inflation projections remaining above target through 2026. Inflation is expected to be sticky considering how little this year’s forecast was revised, down only 0.2ppt to 3.7%. Oil prices having risen nearly 30% since end-2Q23 are expected to contribute to global headline CPI inflation by 1 to 2 ppt annualized in 2H23 than would otherwise be the case. In the event crude prices drop back to below $90/bbl next quarter, the pass-through into core inflation should be muted. A bigger concern would be if central banks are less able to look through any upside price shock. There is also a risk that the recent oil supply cuts are not finished, and energy prices could jump much further, potentially altering the disinflation process underway.
Rising expectations that the Bank of Japan may move towards tightening, has seen sell-off in the long end of the JGB curve and 30-year JGB yields at their highest levels since 2013, exceeding their previous peaks in October 2022 and January this year. In turn, this raises questions about further impact on global yields as well as bond volatility. For Japanese investors, inverted foreign yield curves have increased the cost of hedging foreign exchange risk and made it less attractive to hold foreign bonds relative to extending further along the domestic curve. Since 2Q22, US Treasuries no longer offer a pickup to Japanese investors relative to 10y JGBs using 3-month rolling FX hedges, which they have partially unwound previous accumulation of holdings. This still leaves a remaining base that could be reduced further. In the event of a decline in the value of domestic bonds relative to foreign bonds, it would likely prompt some rebalancing away from foreign bonds to domestic bonds, placing pressure on the former.
In China, positive momentum appears gathering with both manufacturing and services official September PMIs above forecasts, amid recent stimulus measures aimed at increasing consumer disposable income and property transactions. On financial conditions, August total social financing increased RMB 3.12 trillion, +9.0% year-on-year, vs increase of RMB 528 billion in July, which was the lowest monthly number since August 2016. New loan creation also showed a recovery, reaching RMB 1.36 trillion following July’s RMB 346 billion. Meanwhile, the PBOC made its second reserve requirement ratio cut of 25 bp this year. The RRR cut is estimated to inject RMB 500 billion liquidity into the banking system, with the average RRR dropping to 7.4% from 7.6%. Further fiscal and property policy adjustments may follow, including fiscal subsidy for product-specific consumption support and more housing policy easing. This is in line with expectations of growth stabilization policies being incremental but are nevertheless required to maintain momentum.
Fixed Income Strategies
As the debate over the US tightening cycle is pushed further out, it is unsurprising that markets are now pricing in a greater than 60% probability of another hike in coming months, and terminal has been pushed out further, with the peak forward rate being priced in December 2023, while at the same time not pricing in a full ease until 2Q24. The front end could find relatively more stable footing around current levels, although there is significant risk that long end yields may not have seen their cycle peaks, with declining employment levels rather than faster disinflation likely being the catalyst to when yields top out. Separately, energy prices remain a risk: amid their rise, TIPS breakevens have been widening, supporting higher nominal yields. We look to maintain shortened rates duration of bond portfolios.
Credit spreads are broadly unchanged even as core rates surge, attributed to the current soft landing expectations increasing demand from all-in yield investors. One pushback to this narrative is that tight monetary policy is leading to fundamental credit metric deterioration, albeit at a slow pace, which should lead to more refinancing difficulties and perhaps driving up defaults. Overall, leverage and interest coverage ratios are deteriorating as the rise in funding costs gets reflected. Every day that high grade borrowers replace low coupon maturing bonds with higher coupon new issues raises the pressure on credit metrics. Combined with the alternative of higher risk-free rates making credit less appealing, a material tightening in spreads during 4Q23 is unlikely. Among sectors, oil and gas producers are relatively more insulated on underlying demand and falling global oil inventories.
The China real estate sector’s share of new bank lending, at a record-low 1% in 1H23, is indicative of challenging financial conditions for the sector and could continue to languish at low levels. Lower mortgage rates and downpayment ratios may offer a slight boost to larger cities’ home sales, but new capital rules suggest banks will likely be reluctant to lend to financially stressed privately-owned developers. The top SOE and POE developers seem better positioned to operate in the current environment, given relative strength of their credit metrics including adjusted liabilities to assets ratio, debt to equity ratio and cash coverage on short term debt. Admittedly, across the sector are signs of fundamental deterioration over the course of 1H23, including an average 10% decline in liquidity coverage and a slight pickup in net gearing. For weaker developers, concerns remain on the lack of direct help with refinancing and asset monetization. Piecemeal policy support currently focuses on demand factors such as project completion. Defaults can be expected to increase as and when weaker developers throw in the towel. Maintain positions in developers that demonstrate prudent liquidity management and access to financing.
Real Estate Sector Share of China New Lending
Source: Bloomberg Finance L.P.
In the US, the Feds made the decision to maintain the current rate at 5.25% – 5.50% with indication of a further rate hike before the year ends. Post the hawkish Pause, US Equities posted a pullback. As previously reiterated, we recommend to gradually accumulate on any material market dips at more reasonable valuations in selected US technology counters as well as in defensive and laggard sectors such as consumer staples and healthcare, which offers more attractive risk/reward should the US economy enters into a soft landing in 2H’23.
For HK/China, we are and still remain cautious of the inadequacies of the policies and smaller scale stimulus implemented thus far to revive the economy. Nevertheless, we note that the real estate sector is showing initial signs of stabilisation as the conscientious efforts of the Chinese government lift hopes that they stand ready to provide the necessary relief/support should the economy continue to deteriorate. We believe the Chinese government will likely continue to monitor the outcomes of these implemented measures for some time before any major step-up in stimulus, if any, is considered. Hence, we anre of the opinion that any further significant stimulus, if materialize, will likely come later rather than sooner. Against these backdrops, we recommend investors to consider gradually adding some selected Equities exposure in HK/China in a staggered approach on significant market pullbacks while patiently awaiting 1) signs of recovery in the Chinese economy as a result of the current slew of smaller scale stimulus implemented or 2) further major stimulus, in particular those targeted at the real estate sector, that could revive slowing growth and market sentiment. Furthermore, we recommend a significant portion of these selected HK/China Equities exposure to be gained through Index ETFs rather than individual securities in order to mitigate market and P&L volatility and in the worst case, if further major stimulus fails to materialize.
Our preferred sectors are Technology, EV-related and Travel-related industries. We are also inclined towards infrastructure-related names in view of a potential accommodative policy stance. These sectors are trading at attractive valuations, be it from a longer-term fundamental perspective or that of a short-term swing trade. We also continue to be advocates of defensive sectors such as Telecoms and Utilities that provide reasonable dividend yields with decent valuation upside. While we continue to monitor key data points, in particular those that could lift the real economy, market sentiment and hence a rebound in Equities, we reiterate that portfolios should stay nimble and diversified.
William Chow – Deputy Group CEO
Mr. William Chow brings over two decades of asset management experience and currently oversees Raffles Family Office’s (RFO’s) Advanced Wealth Solutions division while also serving on its Board of Management and Investment Committee.
He joined RFO from China Life Franklin Asset Management (CLFAM), where as Deputy CEO from 2018 to 2021 he oversaw $35 billion in client investments. William also chaired the firm’s Risk Management Committee and was a key member of its Board of Management, Investment Committee and Alternative Investment Committee. Prior to CLFAM, he spent 7 years at Value Partners Group, the first hedge fund to be listed on the Hong Kong Stock Exchange, where he was a Group Managing Director. He started his career at UBS as an equities trader and went on to take up portfolio management roles at BlackRock and State Street Global Advisors from 2000 to 2010.
William holds a Master’s degree in Science in Operational Research from the London School of Economics and Political Science, and a Bachelor’s degree in Engineering (Hons) in Civil Engineering from University College London in the UK.
Derek Loh – Head of Equities
Mr. Derek Loh is the Head of Equities at Raffles Family Office. Derek has numerous years of work experience from top asset management firms and Banks – 16 Years on the Buy-side across 3 Major Cities in Hong Kong, Singapore and Tokyo. Derek demonstrates in-depth industrial knowledge and analysis, covering mostly listed equities.
As an Ex-Portfolio Manager for ACA Capital Group, Derek managed a multi-billion-dollar global fund for a world-renowned sovereign wealth fund and reputable institutional investors. Previous notable investors serviced include Norges Bank (Norwegian Central Bank), Bill & Melinda Gates Foundation and Mubadala. Derek holds an Executive MBA from Kellogg School of Management and HKUST. He is also a CPA.
Ek Pon Tay – Head of Fixed Income
Mr. Tay Ek Pon is responsible for fixed income investment management at Raffles Family Office. He has over 20 years of fixed income experience across Singapore and Japan.
Prior to joining Raffles Family Office, Ek Pon was a portfolio manager at BNP Paribas Asset Management since 2018, responsible for Asia fixed income mandates. From 2016 to 2018, Ek Pon led the team investing in Asian credit at Income Insurance. From 2011 to 2016, he worked at BlackRock, managing benchmarked and absolute return fixed income funds. Earlier in his career, he held several positions as a credit trader in banks for 9 years.
Ek Pon graduated from the University of Melbourne with a Bachelor of Commerce and Bachelor of Arts.
Sky Kwah – Director, Investment Advisory
Mr. Sky Kwah has over a decade of work experience in the investment industry with his last stint at DBS Private Bank. He has achieved and receive multiple awards over the years being among the top investment advisors within the bank. He often deploys a top-down investment approach, well versed in multiple markets and offering bespoke advice in multiple assets and derivatives.
Prior to his role at Raffles Family Office, Sky worked at Phillip Capital as an Equities Team leader handling two teams offering advisory, spearheading portfolio reviews and developing trading/investment ideas.
He has been interviewed on Channel News Asia, 938Live radio, The Straits Times and LianheZaobao as a market commentator and was a regular speaker at investment forums and tertiary institutions.