[T.S.R:16702] Societe Generale: Something's Gotta Give As Rate Hikes Bite Across EM Asia; Negative EM Asian Equities

EM Asia rates set for bear-flattening pressures at frontend and bear-steepening pressure further out

 

In China, heightened concerns over aggressive rate hikes and removal of policy accommodation led to a significant sell-off at the front-end. PBoC raised benchmark deposit and lending rates in October, the first time since 2007 and increased the reserve requirement ratio (RRR) by 2.5 percentage points to 18% for major banks in 2010.  

SG Economics forecasts the PBoC hiking again before yearend and delivering three hikes in 2011, taking the 1-year deposit and lending rates to 3.50% and 6.50%, respectively. CNY 2y-5y IRS having steepened initially from 70bp to 90bp post rate hike has since flattened significantly to 47bp, spooked by hawkish PBOC rhetoric and upside economic surprises. Expectations of ample liquidity conditions were short-lived as the money market (7-day repo fixings) rose by 140bp to 3.35% since October. 

We do not recommend going against current bearish sentiment in CNY IRS at the beginning of 2011. Interest rate hike expectations are likely to accelerate if a further rate hike is delivered before year-end. It is highly probable that the front-end of the curve will flatten to single digits towards the end of the rate hike cycle as seen in the CNY IRS curve during the 2007-2008 tightening period. CNY 2y-5y IRS spot at 50bp and 1-year forward remains relatively steep at +32bp, and there remains plenty of room for potential flattening of the curve. It is a cheap bearish play compared with negative carry of more than 8bp per month of paying the 1y and 2yr tenors of the CNY IRS curve. We recommend CNY 2y-5y flattener at 50bp, target 0bp, stop +65bp, negative carry 1.5bp a month.

 

Attractiveness of spreads and curve based on degree of policy accommodation. Based on our economists' Taylor Rule analysis, Singapore, Hong Kong and China have the loosest monetary policies. We see the most risk in a bearish move in China rates. HKD is expected to continue to track USD movement and we prefer range and mean reversion trades. In terms of outright positioning, the trading range between HKD and USD IRS is too wide, around 60bp and 80bp range with HKD trading at a premium against USD. Box trades between HKD and USD IRS have a smaller trading range, between 0-20bp where the HKD curve tends to trade flatter than its USD equivalent.  

We maintain a range trading strategy on HKD / SGD IRS in both outright and curve terms against the USD curve. The structural curve segmentation in SGD IRS is expected to continue. The front-end of the curve is driven by the SGD 6-month Swap Offer Rate Fixings (SOR)

61 which in turn is determined by SGD currency valuation. A strong SGD is expected to be supportive for the front-end, which leaves the short-end curve directional, i.e. SGD strength to lead lower front-end SGD IRS rates and vice versa. The longer-end of the SGD curve is more supply/demand driven and highly sensitive to corporate issuance flows.

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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