As much as 2022 was a tough year driven by high inflation, after-effects of the pandemic, and a burst in rate hikes, 2023 was even more so as known unknowns became unknown unknowns. Markets expected a slowdown in rate hikes and possibly a peak in interest rates sometime in 2023. In hindsight, this happened in a relative sense with the US Federal Funds rates peaking at 5.25%–5.50% in late July 2023 and remaining on pause since then.
However, it was not a smooth sailing pause as the US economy continued to signal signs of strength at certain periods instead of the expected economic cooldown, and global markets through 2023 dealt with the arduous and painstaking process of trying to curb the rise in prices due to sticky inflation. Solid economic data and resilient earnings in 3Q2023 resulted in 2Y (high of 5.2% in October 2023) and 10Y (5.0%) UST yields reaching 16- and 17-year highs respectively per Bloomberg.
UST yields plunged post-easing inflation and dovish FOMC policy pivot in the last two months of 2023.
That said, the highs of UST yields in October were brief, with lower inflation numbers and commentaries by companies indicating that some pockets of consumer weakness were beginning to show, injecting market optimism that the prospects of rate cuts were near. Treasuries swung lower and risky assets were boosted through the last few weeks of 2023. The Federal Open Market Committee’s (FOMC) recent dovish policy pivot and the implication of rate cuts of 75bps in 2024 have led to a steep decline in the 10-year US Treasury yield, which is now around 4% (2023’s peak of around 5% in October). This shift in policy, combined with decelerating inflation readings, suggests that the higher-for-longer rates narrative is closer to coming to an end. Stable or lower rates in 2024 could improve risk sentiment and benefit/risk assets in 2024. As a result, there is a good chance that credit markets could offer decent returns to bondholders.
SGD credit markets rebounded in 2023 amidst lower rates but bond issuances fell to a 5-year low
SGD (Singdollar) credit markets gained 7.6% in 2023, which more than claws back its losses of 6.8% in 2022. Investors benefited when interest rates (10Y SORA fell 46bps year-on-year to 2.58% as at end 2023) tumbled from their peak, like the recoil of a stretched rubber band, due to increasing expectations of Fed Fund rate cuts in 2024. The underperformer in 2022 has transformed into a market darling, with long-dated issuance posting +14.5% returns in 2023 (2022: –17.7%). Other buckets also performed well, including mid-tenor papers (+7.9%), Tier 2 bank capital instruments and other non-perpetual subordinated papers (+7.8%) and non-financial perpetuals (+7.1%).
Despite the total writedown of the Credit Suisse Group AG Additional Tier 1 bank capital instruments (AT1s) that represented about 7% of the SGD AT1 market, total returns for AT1s were +2.5%. That said, peaking interest rates, unexpected economic data, Federal Reserve uncertainty, and geopolitical tensions impacted global credit markets including SGD where bond issuances fell to a 5-year low of $17.7 billion (–20.2% year-on-year) across 84 issues as issuers resisted the higher funding costs and tighter credit spreads. Government-linked issuances were affected by the inactivity of HDB but partially offset by issuance from financial institutions, driven by their resilient fundamentals and balance sheets.
Bye to 2023, Buy in 2024?
Our theme for 1H2024 is to “buy while rates are still high”. Our credit outlook for the first half of 2024 aligns with our second half of 2023 Singapore credit outlook, but with some adjustments:
See also: US bond market halts brutal run as buyers pounce on 4.5% yields
We seek to position in the belly and long tenors when opportunities arise (e.g. primary issuance). We believe issuers may look to lengthen their maturities in 1H2024. While longer-end rates have fallen alongside short-dated rates in recent weeks, the continued fall in longer-end rates is likelier to be capped versus the shorter end going into 1H2024. Our preference for belly and long tenors versus shorter-dated bonds is driven by rising reinvestment risk. While long-end rates could remain uncertain in the coming months, we think the likelihood of significant capital losses due to runaway rates has decreased, versus the beginning of 2022 which necessitated a focus on capital preservation.
While lower rates and lower recession risks in 2024 are expected to support risk sentiment and risk assets, we remain cautious due to ongoing global uncertainties. It is still too early to allocate higher proportions in real high-yield or distressed credits in the first half of 2024, even with potentially somewhat improved funding environments. There are select opportunities in crossover credits, but investors should continue to focus on bottom-up analysis, even if the funding environment improves somewhat in the first half of 2024.
We maintain a “neutral” stance on corporate perpetuals and urge caution regarding non-call and reinvestment risks. Falling rate environments pose a double-edged sword for corporate perpetuals, as the new reset coupon rate may not be high enough to incentivize issuers to call them. Even if these perpetuals are reset at a high coupon rate, perpetual holders may also need to take into consideration high reinvestment and call risks amidst a falling rates environment as the issuers normally have the option to call back the perpetual every six months after the first callable date. Perpetual holders may get back the capital (when perpetuals are called by issuers) during low-rate environments and realise there are no longer attractive yields available to invest by then. In general, the option value increases for issuers in a falling rate environment.
In contrast, bank capital instruments, such as AT1 and Tier 2 securities, could be more attractive in a falling rate environment. Banks tend to call back these instruments on the first callable date, and they offer structurally higher returns from high-quality and regulated issuers and lower prices compared to senior issues. However, careful consideration of its structure and bottom-up selection is crucial given rising credit dispersion in the financial institutions sector.
We no longer have an underweight position in any sector within the SGD credit market. Credit has shown resilience as an asset class and can act as insurance against a global growth slowdown and possible recession. While value may be scarce due to the demand for SGD-denominated papers in 2023, any potential drop in rates and widening of credit spreads may uncover opportunities for investors.
As for the outlook for major sectors in the Singapore credit market:
REITs’ outlook mixed depending on asset location
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Elevated interest rates have led to higher refinancing costs for Singapore REITs (S-REITs) as their debt matures. Overall, we expect many S-REITs will continue to refinance debt at a higher cost going into 1H2024. We expect the increase in interest rates to negatively impact property valuations, with reported aggregate leverage tilting upwards. That said, the specific magnitude of change is highly dependent on the geographical market, property specification and valuation norms. The underlying operating performance of the Singapore property market has been exceptionally resilient relative to cities globally, although we are more cautious over S-REITs whose property portfolios are tilted towards geographical markets and property sub-segments where the outlook has weakened.
Resilient Singapore property outlook
Private residential prices are expected to rise by 3-5% in 2024, following a 6.7% increase in 2023. Demand should remain resilient, supported by the growth in resident population (including new citizens and permanent residents), the strong financial position of Singapore households, and the aspirations of young residents to upgrade. Despite government land sales increasing to a 10-year-high, the market should not become oversupplied as the number of unsold units remains low. We expect certain developers to opportunistically increase exposure to the Singapore property market, and they may return to the SGD bond market in 2024 should capital needs arise.
Stable financial institutions’ outlook
We expect stable fundamentals for the financial institutions under our coverage as higher interest rates and benign credit quality should support earnings performance while credit ratios remain comfortably above minimum requirements. The key risk for bank capital instruments of non-call risk (above distribution risk and write-down risk) has increased in our view due to regulatory drivers. Considering these influences and the tighter spreads in the SGD bank capital space, we maintain our neutral call on bank capital instruments. We continue to view bank capital instruments from a bottom-up perspective rather than a topdown perspective.
Andrew Wong, Ezien Hoo, Wong Hong Wei and Chin Meng Tee are credit analysts with OCBC
