Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
13 June 2023
“All eyes on the upcoming FOMC meeting, with market largely expecting a rate hike pause”
Since the resolution of the debt ceiling last week, focus has shifted back towards the upcoming CPI data print and FOMC Fed Funds rate decision due to be released on 13th of June and 15th of June respectively. Good news is that the CPI has continued to decline, and all signs point to a FED Rate Hike pause in the upcoming June FOMC. However, the US Inflation number is still some distance away from the FED’s target of 2%.
Wage growth and shelter, which have been the largest contributors to US Inflation seem to have peaked and have been declining since Q3 2022. Figure 1 shows the average median forecast of the CPI (YoY %) and FED Funds rate for the upcoming quarters. The markets are still expecting 1-2 rate cuts of 25bps before the end of 2023. That being said, the markets are also pricing in a 52% probability of a final 25bps hike in July’s FOMC meeting.
Figure 1: CPI Inflation vs. Federal Funds Rate
Figure 2 represents the analyst forecast of the CPI (YoY%) for the upcoming 5 quarters. Interestingly, economists from Bloomberg and Oxford are predicting a slower decline in the CPI relative to analysts from the major financial institutions.
Figure 2: CPI (YoY%) Analyst forecasts
Figure 3 – Caixin/S&P’s composite PMI, which includes both manufacturing and services activity, picked up to 55.6 from 53.6 in April, marking the quickest expansion since December 2020. (The 50-point mark separates expansion from contraction in activity.) China’s economy rebounded faster than expected in the first quarter but lost momentum at the beginning of the second as April data broadly undershot forecasts.
Figure 3: Caixin/S&P’s composite Index
Furthermore, the rebound was unbalanced with a disproportionately heavy contribution from services vs. manufacturing. In the manufacturing sector, employment deteriorated, prices plunged, and manufacturers became less optimistic toward the forward 12-month outlook – According to the Caixin China manufacturing PMI. This divergence highlights that the economic recovery lacks internal drive and companies lack sufficient confidence. Further policy support might still be required to boost domestic demand.
This has been reflected in the relative outperformance of the S&P 500 (+12.68%) vs. the Hang Seng Index (-2.44%) YTD, despite the various uncertainties in the US. However, the pessimism over Chinese markets may reverse with the announcement of further stimulus. In the past week, the Chinese authorities have signalled a willingness to do more to lift certain sectors, including real estate and manufacturing, and boost demand. On 8th June, some of China’s biggest banks lowered rates on their medium-term deposits, responding to the government’s call for help in boosting growth in the economy.
The volatility skew of the Hang Seng Index shows that 3M Calls are now traded near the smallest discount against puts in almost two years. That’s a contrast to the previous bear market up until October 2022, when puts were far more expensive as investors sought a hedge against the downside risk in equity prices. It is now becoming increasingly attractive to be long upside optionality in the Chinese Markets to hedge against a sudden rebound, especially for investors who are underweight China/HK.
Fixed Income Macro
A surprising increase in the global May manufacturing PMI alongside strong gains in US April goods spending and payrolls are deferring concerns over an imminent recession. Extension of the US debt ceiling removes a significant downside risk to the growth outlook and increases chances of the Fed continuing its tightening cycle, potentially after skipping a rate hike at the June FOMC meeting. A skip would allow the FOMC to consider more data before making decisions about the scope of additional policy firming. Overall, with most FOMC members either signalling a hold or further hikes, and a US economy that appears to be holding up well despite the policy rate increasing 500 bp since March 2022, expect some hike premium to persist near term.
One of the expected consequences of new US debt ceiling suspension is the flood of bill issuance to replenish the US Treasury’s cash balance. Given Treasury forecasting a $600 bn cash balance for end 3Q23 and cash balance at $37 bn as of end-May, implies the cash balance will need to rise by more than $550 bn over the next 4 months. This means bank reserves at the Fed, and consequently bank deposits, are expected to face downward pressure in coming weeks. Presenting another challenge for banks to retain deposits, an increase in deposit funding costs and net interest margin compression, is likely to keep tightening credit conditions going forward.
In China, the uneven economic recovery continues. Service sector activity outperformed; May non-manufacturing PMI at 54.5 remained elevated, with solid readings for travel, catering/restaurant spending and other reopening sectors. In contrast, manufacturing PMI fell to 48.8, along with May exports falling a second consecutive month. Near term, expect the PBOC to refrain from cutting policy rates (reverse repo and medium-term lending facility rates) or banks’ reserve requirement ratio. This allows the PBOC to preserve more policy options on expectations that DM central banks are not done with their hiking cycle. Instead, the PBOC is likely to implement targeted measures to support credit growth, such as recently advising banks to cut deposit rates, enabling them to lower lending rates.
Fixed Income Strategy
Since US economic data has outperformed relative to consensus expectations and debt ceiling risks dispelled, bond yields have risen over the last two weeks to near their highest levels since the US regional bank turmoil in 1Q23. Front end yields are likely to remain elevated relative to the long end given the overhang of the potential ramp-up of Treasury bill issuance in coming months. The impact of higher money market rates from the surge in issuance could exacerbate deposit outflows from vulnerable regional banks, increasing risks of another liquidity event. Meanwhile, Fedspeak is indicative of skipping a hike during the June FOMC based on the lagged effects of tightening in policy rates so far. Taken together, maintain rates duration longs in bond portfolios.
We are skewed towards quality credit positioning. As rate increases started to bite, interest expenses paid by global corporates surged 15% in 1Q23, according to S&P. Sharply rising interest payments will likely remain a key theme of quarterly results through the year, and with global EBITDA growth turning negative for the first time since 3Q20, interest cover is starting to fall. While cover remains significantly above its pandemic lows, deteriorating EBITDA and rising interest costs will likely bring a sustained drop. For weaker credits particularly, reliance on floating-rate debt means falling EBITDA and rising interest costs are more immediate threats to credit quality.
Companies Interest Paid Vs Total Debt Is Set To Increase This Year
Source: Bloomberg Finance L.P.
We are also maintaining positioning in China central SOEs vs underweight China LGFVs and regional bank bonds. China’s uneven economic recovery year to date exacerbates credit risks in the LGFV sector, especially for the most indebted and/or less developed inland regions, e.g. Tibet, Qinghai, Yunnan, Heilongjiang and Inner Mongolia. LGFV debt servicing ability in terms of interest coverage ratio and cash to short term debt ratio both deteriorated since 2020. This means LGFVs are increasingly relying on local governments to support them on debt service while the latter are facing falling revenue from decreasing land sales. Moreover, refinancing risk is elevated, as LGFV bond maturities are RMB 4 trillion in 2023, the highest in a decade. Regional banks have highest exposure to LGFV financing, followed by SOE banks. As such, there is rising LGFV default risk that may have meaningful ramifications for the financial system.
Our view on the probability of any rate cut this year is currently low as key macro data such as a strong labour market and consumption are still holding up. Our previous recommendation to investors on swing trades in blue-chip Technology stocks should have yielded substantial returns and we are now inclined to gradually take profit/trim some of these positions. With the market expectation of a hike pause at the upcoming FOMC meeting, we are inclined to switch our focus to 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 as widely anticipated.
For HK/China, we continue to remain overweight in beneficiaries of the China reopening theme despite the slower-than-anticipated “reopening” thus far on hopes of potential stimulus from Chinese government in 2H’23 and attractive valuations. We favour Chinese airlines, domestic consumption-related, travel-related and F&B-related sectors. We are also skewed towards infrastructure-related names in view of an accommodative policy stance to support the domestic economy. Despite the recent rebound in Chinese equities from recent lows over the past 2 weeks, these sectors are still trading at attractive valuations and deserve our attention 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 and valuation upside.
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.