Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
18 January 2022
“Earlier Fed Hikes vs China Rate cuts”
“Latest December’s consumer price index (CPI) saw US Inflation hitting 7.0% for the first time since 1982. The Federal Reserve have set to lift interest rates as soon as quantitative easing ends in March. The move may come in earlier than previously expected; expectations on the pace of subsequent Fed Hikes should be gradual – over each quarter of this year.”
Quoting Powell – ‘I would expect that this year, 2022, will be a year in which we take steps toward normalization. That will involve raising the federal funds rate. That will involve ending asset purchases in March and perhaps later this year… to allow the balance sheet to shrink.’
No signal of aggressive stance from Fed.
Figure 1: FOMC Dot Plot (Source: Bloomberg)
China’s zero-Covid policy continues to hurt consumption as we see December’s retail sales data rose by a mere 1.7% year on year (as compared to 8.0% at start of the pandemic).
For the first time since April 2020, the People’s Bank of China (PBoC) cut key interest rates by 10bps. The rate cut will support the local governments’ efforts to raise borrowing for funding of new infrastructure projects. Clearly showing PBoC ramping up on efforts to ease risks to growth from the strict zero-Covid stance.
As we head into 2022, we see the biases of global monetary leaning towards tighter conditions. Expect risk of sharp volatility especially in risk assets at least into the first quarter of 2022. We urge investors to adopt a more conservative approach and be more selective in their investments.
Fixed Income Overview:
We anticipate FED Funds rate to be kept 0% – 0.25%, with three rate hikes each in 2022 and 2023 (FOMC dot plot median at 1.6% by the end of 2023)based on the December 16th meeting.
The credit default swap (CDS)index for Asia ex-Japan Investment Grade entities rebounded to 90 as of 18 January 2022 from 77 as of 4 January 2022.
Asia IG credit spread rebounded to 126 as of 18 January 2022from 118 as of4 January 2022.
Asia HY credit spread rebounded to 1036 as of 18 January 2022 from 877 as of 4 January 2022.
10 Year Treasury rebounded to 1.82% as at 4 January 2022 from 1.62% as at 4 January 2022 (expected to be around 1.25% to 2.25% for year of 2022)
We expect IG bonds credit spreads, except for Chinese issuers, to range bound over the coming months.
We expect sentiment in the HY bond market to remain relatively muted to range despite the recent injection of capital of approximate USD 6.5 billion by various Chinese financial institutions to Huarong, aiding it to serve its debts and prevent a debt default.
Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)
Highly leveraged HY bonds (B rated) may face refinancing/default risks – several onshore/offshore bonds have defaulted recently including bonds issued by Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China, Evergrande, Kaisa, China Aoyuan. Evergrande also announced on 3 Dec 2021 that it planned to “actively engage” with offshore creditors on a restructuring plan.
We caution investors holding marginal investment graded bonds (BBB-, Baa3) to be wary of downgrades. For investors with an investment grade bond portfolio mandate, we recommend bonds with BBB+ ratings or higher, and portfolio duration of 2.5 – 3 years.
We recommend investors to stick to short dated high quality (BB Rated) High Yield bonds (ex-China)with a duration of less than 3 years and be prepared to hold the bonds to maturity.At the same time, reduce/control their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated Chinese real estate bonds. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield with BB ratings excluding China) and neutral on Developed Markets and Chinese bonds.
Further, we recommend investors to match their exposure of high-beta bonds such as: CoCo Bonds, Perpetuals, and high yield bonds to their respective risk appetites. It is also recommended for investors to hold a more diversified fixed income portfolio and to reduce leverage of portfolios due to various uncertainties across sectors. We advise investors to dive deeper into the issuer’s stand-alone fundamentals to ensure the strength of the company.
We recommend investors to continue to monitor low beta bonds. For reference, the purchase yields for 3–5-year low beta IG bonds are at 1-2%, and 3-5-year low beta HY bonds are at 3-5%. Overall, with the expectation of rates going higher and more volatility going into year 2022, we recommend a balanced and more diversified portfolio, with short duration (less than 3 years) IG and high quality (BB rated) HY bonds. Although the absolute returns in the fixed income market may be low, it is still advised to maintain a portion of the portfolio in fixed income given the heightened volatility of the markets.
With the biases of global monetary leaning towards tighter conditions in 2022,expect risk of sharp volatility in risky assets at least into the first quarter of 2022.
Despite the belief that interest rate hikes are generally negative for Equities, we believe it will be the speed, frequency and magnitude of the upcoming Fed rate hikes that will, to a large extent, dictate the direction and volatility of global Equities market throughout this year.
In the near-term, we anticipate a significant pullback in the equities markets, in particular, the Nasdaq (growth stocks in the US) in view of the relatively rich valuations vs other Global Equity markets as well as the looming interest rate hike cycle in 1H’22 that will likely have a greater negative impact on growth stocks.
Fortunately, the US FED has been providing sufficient clarity with regards to their intentions in relation to monetary policies thus far, specifically on how they have been managing market’s expectations. Henceforth, were main constructive on Global Equities for the mid-longer term despite anticipating possible near-term volatility arising from the initial rate hike in the earlier half of this year.
With various headwinds on the horizon, we urge investors to adopt a more conservative approach prior to the initial Interest rate hike anticipated to materialize in the earlier half of this year and stay overweight selective blue chips to mitigate the risks of excessive volatility.
Figure 3: 1-Year chart comparing S&P 500 Index and Hang Seng Index (Source: Bloomberg)
Geographically, we are inclined towards HK/Greater China Equities vs US and Europe Equities heading into 2022, mainly because of the more attractive valuation and better risk/reward. The recommendation would be to stay more defensive initially by holding more cash prior to the initial rate hike by the US FED and await better buying opportunities on the anticipated pullbacks during the same period.
The preferred sectors/themes are:
1. Financials (ex insurance; focus on deposit taking banks across US, Europe and Singapore and to a smaller extent, the major Chinese banks)
2. Automobile / EV related
4. Green Energy
5. Gold (as a short-term inflation hedge)
It is important that investors adopt a well-diversified portfolio overall. Stay nimble by employing more tactical trading while mitigating anticipated volatility with a major overweight in selective blue chips. As always, it is imperative to adhere to strict risk management principles (stop-loss mechanisms and/or appropriate portfolio hedging) to mitigate risks from market swings and uncertainties.
This material is provided for informational purposes only. It is not a recommendation or solicitation of any investment or investment strategy. There is no guarantee that any investment or strategy will achieve its objectives. Unless otherwise stated, all information contained in this document is from Raffles Assets Management (HK) Ltd. and/or Raffles Family Office Pte Ltd (Singapore) and is as of 18 January 2022. The views expressed regarding market and economic trends are those of the authors and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets, or sectors will perform as expected. By acceptance of these materials, you agree that you shall use the information solely to evaluate your investment in this Raffles Assets Management (HK) Ltd and/or Raffles Family Office Pte Ltd (Singapore) sponsored investment opportunity and you shall keep the information confidential.
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 – 13 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.
Ex-Portfolio Manager for ACA Capital Group, managing 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.
Lawrence Chan – Head of Fixed Income
Mr. Lawrence Chan is Head of Fixed Income of Raffles, where he is responsible for credit and fixed income investments.
Mr. Chan has over 15 years of experience in the fixed income industry. Prior to joining Raffles, he was Chief Investment Officer (Fixed Income Investment Department) of Taiping Assets Management (HK) Co. Ltd. to manage China Taiping Group’s offshore bond investments and co-manage MPF & ORSO funds for China Life Trustees. His co-managed China Life Guaranteed Return Fund won various awards from Bloomberg Businessweek (2015-2017), BENCHMARK (2015) and MPF Ratings (2015-2016). He had worked for various financial institutions, including Taikang Asset Management (HK) Co. Ltd., Deutsche Bank AG (HK Branch) and Hong Kong Monetary Authority.
Mr. Chan graduated with a Master’s degree in Finance from The Chinese University of Hong Kong and a Bachelor’s degree in Accountancy (with First Class Honours) from City University of Hong Kong (formerly known as City Polytechnic of Hong Kong). He is a CFA charterholder, Hong Kong CPA, and a Fellow of the Association of Chartered Certified Accountants (“ACCA”).