Rates: Singapore and Hong Kong face the pull of USD rates
SGD and HKD interest rates are feeling the pull from higher USD rates in the leadup to the ongoing Fed meeting (outcome due on Thursday, 2am). While a rate hike is fully priced in, the market is becoming increasingly convinced that the Fed will be able to deliver many more hikes. There also remains upside risks if the Fed revises the dot plot higher yet again. USTs are impacted on two fronts – higher Fed hike expectations and higher JGB and German Bund yields, leading to modest steepening across the curve. The HK govvie curve followed suit with 2Y and 10Y yield changes broadly in line with the US. The SGS curve also bear steepened. However, the outperformance in SGSs is clearer in the front end. We suspect that the market is still heavily positioning for another round of tightening by the Monetary Authority of Singapore (MAS) in October, taking the cue that the SGD NEER is probably close to the top of the band. This kept shorter-term SGD rates (1Y and 2Y) from rising as much.
That said, further updrifts in shorter-term SGD and HKD rates (Sibors, SORs & Hibors) is inevitable if the Fed proceeds to hike in the coming quarters as we expect. While the market is gravitating towards more rate hikes (four by the end of 2019), we think that the pricing is still on the dovish side (we expect six more hikes by end-2019). Secondly, the 3M Libor is heading north again. The normalisation of the Libor-OIS spread is largely done, suggesting that the passthrough from Fed hikes will be meaningful again. Notably, recent MAS bill rates, SORs and Hibors have all come under upward pressure and the rise is not done yet.
FX: Fed on track to take the USD higher
We think the US dollar Index (DXY) will resume its appreciation if tonight’s FOMC meeting pushes the US 10Y treasury yield to a new 7-year high above 3.13% (May’s high). Although markets have fully discounted a 25bps hike in the Fed Funds Rate to 2.25%, the 3M USD Libor has already increased to a new 9-year high of 2.37%. With major US equity indices also having hit new record highs this month, the Fed is likely to look past the escalation in China-US trade tensions and reaffirm its guidance to gradually increase rates to 3% or more in the next couple of years.
We will pay close attention to possibly stronger growth/inflation/rates forecasts in the Fed’s economic projections accompanying the FOMC statement. They may well signal that the Fed is around or just passed the mid-point of its current Fed hike cycle. We continue to look for one Fed hike per quarter taking the Fed Funds Rate and the 10Y yield to 3.50% by end-2019 and see curve inversion emerging as an issue only in 2H19. Hence, USD bears hoping for the Fed to signal a pause in its hike cycle are likely to be disappointed.