“Fed turns Hawkish again – Eyeing for 50bps hike”

Market Overview:

“As expected by market consensus, during the FOMC meeting today, a decision was made to increase the federal fund rates by 50 basis points (bps), raising the current target to 75 – 100 basis points. Additionally, the FOMC is expected to begin the reduction of its balance sheet. What is also important to note is that Powell indicated that raising 75 basis points “is not something the committee is actively considering”. ”

This decision will lead to a readjustment of rates for the upcoming June FOMC meeting and the year-end forecast. The table below (correct as of April) is of the current market participants’ forecast for rates. With an increased pace of 50 bp to combat inflation, yearend consensus would be nearing 275 instead of 225. This would in turn lead to readjustment in companies’ valuation models.

Figure 1: US Fed Target Lower Bound as of Apr (Source: Bloomberg)

US Macro

The household savings rate has fallen below pre-pandemic norms. However, balance sheets are strong, and we still expect more consumer spending on services in the months ahead.

USD Dollar Index Spot (DXY Currency) has reached multiyear high due to headwinds coming from a higher fed fund rate. Beaten down capital markets encourage more buyers, while geopolitical conflict and multiyear high US exports have created a stronger demand of USD.

USD is trading beyond analyst consensus and the 20-year high. As markets continue to price in a prolonged inflation outcome, it should result in a weakening currency in Q3, as inflation is equated with a decrease in the value of the Dollar, while decreasing the number of goods/services that can be bought.

China Macro

GDP Growth beat expectations at 4.8% in Q1 but is highly likely to weaken in Q2. Fixed asset investment growth was 9.3%, pulled by infrastructure and manufacturing; export growth stayed resilient at 15.8%; while retail sales growth was weak at 3.3% due to multiple lockdowns.

The China Politburo met on 29 April. This is basically the principal policy making committee that convenes once a month. Liu reiterated the narratives of:
• Supporting infrastructure construction
• No backing out from Covid 0 policy,
• Progress in the China tech crackdown
• Continue to support various overseas business listing as long as abide to a certain framework
• Resolve property risk and market stability.

The main concern here is all narratives are repeated and not new. Policy makers will need to put action behind words for the rally to be sustained. Thus, we would still maintain a certain China exposure due to valuation reasons but would need prudent asset allocation and risk management strategies.

Fixed Income Overview:

The 10-yr Treasury has hit the multi-year high of 3% when the Fed monetary policy move. This is highest level since Nov 18. Yield have been rising as investors react to inflation running at its hottest, this will in turn punish a lot of dividend yield plays for the year.

Going back to investing basics – The main concern of why I would suggest a reduction of fixed income for the year is because of inflation reasons. In Figure 2. Current inflation numbers on major countries. US 8.5%, Singapore 5.4% and world inflation at 7.9%. The only country that has subdued inflation is Hong Kong and China and 1+%.

Figure 2: Inflation CPI of developed markets (Source: Bloomberg)

Investing in any IG Grade bonds will give you a negative real return in the long run which HY bonds may compensate for with a higher yield but will face higher refinancing/default risk. With Sunac Holdings’ bond payments due in the week of 9 May, this will also give us some further colour on the existing China property sector risk.

We recommend focus on shorter duration bonds and preferably in a structure of a bond fund for diversification purposes and avoiding of a default risk.

Lastly, some consideration on bond funds switches would be moving towards either of the 2 funds below to hedge against rising rates. Currently, they are probably the only positive FI return funds in the market.

Figure 3: Comparison of Funds (Source: Bloomberg)

Equities Overview:

Market is still seeing a huge net capital inflow abroad with US coming in first at 143bil USD and China trailing second at 30bil USD. We are still seeing 2 to 3 times more net flow into equities compare to fixed income due to asset rotation reasons.

Figure 4: Capital Markets Net Flow (Source: Bloomberg)

Investors are very quick to jump into the financial sector in hopes to benefit from the rising interest rate. But this might prove to be a hasty decision as we would have to be very selective in the financials sector. Generally, Singapore local banks and consumer focus banking would benefit for the year as their business model is focused on rates and NIMs. Investment banks like JPM or Goldman depend heavily on market forces and trade/deal flow, thus resulting in them being an underperformer YTD, down 22% and 17% respectively.

I would highly recommend looking into the payment sector to benefit from the rising rates environment, specifically and selectively Mastercard and Visa. The sector will have further tailwind coming from the reopening of global travel and cross border payment.

We should avoid heavily leveraged companies in the high growth space (Squeeze on both valuation and interest expense) or certain property developers. In the REIT space, to avoid low WALE (weighted average lease expiry) companies with low fixed rates as they will be affected in the current environment.

In summary, the global Equities market is expected to face a bigger pull back in the light of earning season ending, adjustments to the new consensus of fed rate and possible risk-off approach. Nasdaq (growth stocks in the US) are at the greatest risk due to their high multiples.

We would recommend some profit taking strategies in the form of a covered call or decumulate on US tech to manage exposure and continue to focus on value over growth stock.