As higher terminal rates from the US Federal Reserve (US Fed) loom, UOB Kay Hian (UOBKH) analyst Jonathan Koh is maintaining “overweight” on Singapore banks.
Banks benefit from the ongoing hikes in interest rates and net interest margin (NIM) expansion on a full-year basis in 2023 with DBS most sensitive to higher interest rates, says Koh. “Shareholders would be rewarded with higher dividends in tandem with the strong growth in earnings. We expect DBS and OCBC to increase dividend per share (DPS) by 17% and 7% respectively to $1.68 (42 cents per quarter) and 60 cents (30 cents each for 1HFY2023 and 2HFY2023) in 2023.”
In particular, OCBC and UOB will benefit from reorientation of supply chain towards Asean countries, says Koh. “Asean countries have a large population of 680 million and account for about 8% of global exports. Many multinational companies have adopted the China + 1 strategy and have plans to set up alternative production facilities within the Asean region. Malaysia, Thailand and Vietnam saw growth in the inflow of foreign domestic investments (FDI) for manufacturing. Indonesia is receiving FDI for the processing of its mineral resources.”
In a Jan 6 note, Koh is maintaining “buy” on DBS Group with a higher target price of $46.95 from $45 previously. Koh is also maintaining “buy” on Oversea-Chinese Banking Corporation (OCBC) with a higher target price of $18.32 from $18.28 previously.
‘Too early for rate cuts’
The Federal Open Market Committee (FOMC) has raised the target for Fed Funds Rate by 50 basis points (bps) to 4.25% on Dec 14, 2022. This is a step down from a series of four consecutive 75 bps hikes.
Fed chairman Jerome Powell has warned that the Fed has “some ways to go” in its efforts to tame inflation. He cautioned that the “terminal level” of interest rates (peak) could be higher than previously anticipated.
Based on the Fed’s dot plot, the median projection for Fed Funds Rate is 5.1% by end-2023, says Koh, an increase of 50 bps compared to the previous survey conducted in September 2022. “We expect the Fed to hike 50 bps on Feb 1, 2023 and taper to a 25 bps hike on March 22, 2023. The Fed Funds Rate should reach a peak of 5.0% by mid-2023 and remain at elevated levels in 2H2023.”
It is still too early to talk about rate cuts, says Koh. “The committee needs more evidence to be confident that inflation is on a sustained downward path. Fed Chair Jerome Powell broke down inflation into three buckets: inflation for goods has already eased as supply chain disruptions were resolved and demand shift to services, inflation for housing services is expected to ease in 2023 as rents for new leases have declined, and inflation for core services (non-housing) is expected to take a longer time to moderate due to high labour content of 55%, elevated job vacancies and growth in wages.”
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The committee expects core Personal Consumption Expenditures (PCE) inflation to recede gradually to 3.5% in 2023 and 2.5% in 2024.
The labour market is too tight, adds Koh. “Demand substantially exceeds the supply of available workers. Companies are reluctant to lay off workers because it is difficult to hire new staff. The size of the labour force is affected by accelerated retirement and slowdown in immigration. There appears to be a structural shortage of about 4 million workers.”
Core PCE inflation at 4.7% in November 2022 remains above the Fed’s long-term goal of 2%. Thus, there will be ongoing rate hikes to ensure that the stance of monetary policy is sufficiently restrictive to return inflation to 2% over time, notes Koh.
“The committee intends to maintain a restrictive policy for some time and cautioned against prematurely loosening monetary policy. Based on the Fed’s dot plot, the Fed Funds Rate would be cut by 100 bps to 4.1% in 2024,” he adds.
As at 1.47pm, shares in DBS are trading 19 cents lower, or 0.55% down, at $34.59; while shares in OCBC are trading 4 cents higher, or 0.32% up, at $12.48; and shares in UOB are trading 16 cents lower, or 0.52% down, at $30.81.
