Economists at UOB Global Markets & Economics Research expect both the Sora (Singapore overnight rate average) and yields on 10-year Singapore Government Securities (SGS) to move higher from current levels.
“Our forecasts for short-term interest rates are poised to head higher into the first half of 2023. We see … Sora at 2.60% by end 2022,” the UOB economists say in an update on July 28, the day after the US Federal Reserve Board announced a further 75 basis points (bps) hike in the US Federal Funds Rate (FFR).
Following the latest hike, the FFR is now at 2.5%, the highest since 2019. During that rate hike season, which took place from 2017 to 2019, the pace was a lot more measured.
UOB economists are particularly hawkish and expect the FFR to peak at 4% by March 2023. The correlation between US rate hikes and Sora has been almost 100% with Sora rising in tandem, albeit at lower absolute levels. If FFR moves to 4%, Sora would probably be fluctuating above 3.5% to 3.6%, which is more than twice its current level. Sora had risen to the 1.8%–1.9% range but has since retreated sharply.
As for the yield curve of US 10-year treasuries, it rises and falls ahead of FFR trends and levels. The problem with the US yield curve now is that shorter-term treasuries are trading at higher yields than the 10-year treasury yields. Following the Fed’s hike on July 27, yields on two-year treasuries are at 2.99% and yields on 10-year treasuries are at 2.79%, and the yield curve remains inverted.
“In our view, the gathering of dark clouds is likely to persist going forward. As such, longer maturity yields will continue to handicap the possibility of a recession. For developed markets, this will translate to a more modest potential for yield upside than otherwise. We see 10-year US treasury and SGS yields at 3.60% and 3.20% respectively, by end 2022,” the UOB economists state. Yields on 10-year SGS retreated from a high of more than 3.24% in mid-June to 2.71% as at July 27.
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During his post-decision press conference, US Federal Reserve chairman Jerome Powell is reported to have said another “unusually large” increase could be appropriate at the Federal Open Market Committee (FOMC) meeting next September. On the other hand, Powell said it would be appropriate to slow the pace of increases as rates get more restrictive.
Getting to FFR of 4%
The UOB economists expect a 50bps rate hike in September and November, and 25bps in December. “Expectations remain firm for the Fed to continue with its rate hikes in 2022 but the path has become more uncertain, given the shift to “meeting by meeting” basis,” the UOB economists say.
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At any rate, with these additional hikes in September, November and December, FFR would have risen by 350 bps in 2022, taking it to as high as 3.75% by end 2022, the highest level since the Global Financial Crisis.
A 25bps rate hike in 1Q2023 will take the FFR to 4% which is when the UOB economists expect a pause.
For some economists, the main positive takeaway from the press conference was a reluctance by Powell to give explicit forward guidance for September’s FOMC. Instead, he said decisions are likely to be based on incoming data. Although most economists reckon the US is in recession, Powell does not seem to think so, citing job growth as one of the reasons.
“The subtle changes in the FOMC statement, as well as the comments made by Chair Powell in the press conference, reinforce our expectation that by September the Fed will be raising rates at a less aggressive pace. Given the slowdown in demand, fewer signs of overheating in labour markets, and the likely downtrend in inflation over the second half, now that the Fed has turned roughly neutral we expect it to take more cautious steps as policy turns restrictive. We look for a 50bps increase in September, followed by 25bps increments in subsequent meetings,” says Bill Papadakis, macro strategist at Lombard Odier, in a research note.
Whatever the case, the trend of FFR is upwards. But will the anticipation of peak FFR rates cause US treasury yields to peak and ease further? Perhaps, and if so, that would lift equity markets, in particular yield sensitive securities such as REITs. Stay tuned.
