The banking sector — including Singapore’s — is highly sensitive to interest rate movements made by the US Federal Reserve (Fed), as any changes introduced by the US central bank may impact their margins. When the US Fed began hiking interest rates from 2022 to 2024 to combat high inflation levels — the highest seen in decades — banks benefitted from higher net interest margins (NIMs), a measure of the bank’s profitability.
The much-awaited US Presidential election on Nov 5 resulted in a red sweep, with the Republicans winning most of the seats in the Senate and candidate Donald Trump in the White House. As of Nov 11, the Republicans are also inching towards clinching control of the US House.
The results imply that the president-elect’s mandate of raising tariffs on imports from China and other countries and tax cuts for the rich are likely to be implemented. Assuming the US Fed maintains its independence, Asia-Pacific — and Asean in particular — may need to brace themselves for a spate of interest rate rises in the next two years.
Tariffs, inflation, interest rates and economic growth are part of a jigsaw puzzle. The US economy was on a path of “no landing” (almost a Goldilocks scenario) before the Republicans made a clean sweep. With the elections out of the way, the road ahead is much murkier.
Tariffs are, in effect, a sales tax on Americans, which may well fuel inflationary pressures and cause the Fed to start raising rates again. Even if the Fed loses its independence, interest rates will rise because of the large and liquid bond market.
Initially, such policies will be favourable for banks, including the Singapore banks, which are amply capitalised and have performed admirably during the 2022–2024 interest rate cycle.
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JP Morgan says its foreign exchange (FX) team sees a 7% strengthening in the broad US dollar (USD) index, with the US Treasury yield curve bearishly steepening by 40 basis points (bps) and volatility to be higher. Notably, this is good for banks initially until their customers feel the pain, and obviously, higher interest rates are negative for S-REITs.
“This supports Singapore banks (beneficiaries of higher and steeper yield curve) and industrials (US-Singapore Free Trade Agreement and onshoring), but is detrimental for REITs (due to higher rates & China exposure),” the JP Morgan report states.
A rising rate scenario will likely support a more positive outlook for the local banks. While DBS Group Holdings initially guided for its FY2025 net profit to be lower than that of FY2024’s levels in its 3QFY2024 ended Sept 30 results, group CEO Piyush Gupta said at the bank’s results briefing that the remarks were prepared before Trump won the 2024 US presidential race.
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On Nov 6, JP Morgan immediately released a report upgrading the Singapore banks to overweight “to capture the upside for higher rates”.
There is still some uncertainty, JP Morgan says. “How much will rhetoric translate into policy? Policy commentators believe the first 100 days of a Trump 2.0 could focus on executive authority related to immigration, energy and deregulation, with tariffs phased in later. How will other governments and companies react to actual policies on FX, trade rerouting and domestic stimulus?” asks a report from the JP Morgan team led by Rajiv Batra, and including banking analyst Harsh Modi, real estate analysts Mervin Song and Terence Khi.
“On the flipside, we downgrade REITs to underweight as the sector might retest 12-month lows as US yields approach new highs,” the report points out.
Higher for longer
Economists almost unanimously agree that the US election results are likely to fuel inflation, with the 10-year US Treasury yield already indicating higher interest rates.
Blerina Uruçi, Chief US economist at T Rowe Price, points to the sharp tightening in financial conditions, such as the surge in 10-year US Treasury Yield, [which, as at Nov 11, stood at 4.306%], could dislodge the economy from its current positive equilibrium “and would make me downgrade my view on the US economy”.
She reckons that with higher tariffs and significantly looser fiscal conditions under the Republican Sweep, inflation would take longer to converge to 2%. As a result, the Fed would deliver fewer cuts, if at all, and the long end of the treasury curve would respond with higher term premia.
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Would tighter financial conditions make the Fed more dovish as it worries about the full employment mandate?
“Finding itself in a bind with expected higher inflation and risks to higher unemployment, it is unclear how this Fed would react. When inflation was much higher, it was a given the Fed would prioritise price stability. A weaker global macro backdrop would likely have [a] modest second-round effect on US growth.” In her report, “retaliation in response to US tariffs would pose another downside risk, if and when implemented,” Uruçi says.
What would a unified Republican government do? “Specific Section 301 tariffs on some trading partners are likely to be implemented first through executive action,” Uruçi says.
The economic effects of tariffs are two-fold. First, they will increase the price level of targeted goods (one-off shock), although the full pass-through to consumers will depend on how much the USD appreciates and what portion is absorbed in the profit margins of foreign and domestic firms. Secondly, tariffs will dampen real purchasing power and consumption of US households, while capital expenditure spending and hiring could be weaker because of a more uncertain business climate.
To offset this, the Tax Cuts and Jobs Act (TCJA) would be extended to lower corporate taxes further. However, given the elevated deficit and debt levels, there is limited fiscal space to offset a large negative shock to growth. Tariff revenues are a wild card and could help lower the revenue spending gap.
“We don’t think tariffs would be mostly limited to China imports, as they were in the first term. Risks of tariffs on Europe and Mexico should be taken seriously, even though practical and legal constraints may make implementation different than what’s been promised on the campaign trail,” says Morgan Stanley, adding that markets may need to price in “in a variety of tariffs scenarios and related growth pressures”.
When asked about tariffs, DBS’s Gupta says it is better to “wait and see”. Trump has said he will implement 60% of tariffs on Chinese goods. “I find it hard to believe they will actually follow through on that policy.”
Similarly, Helen Wong, group CEO of Oversea-Chinese Banking Corporation (OCBC), says it is too early to discuss a response. “We haven’t even heard from the President-elect, and he hasn’t been sworn in yet. Early next year, we will be re-looking at our plans. We’ll be able to give some more guidance on NIM for the year along with loan growth for the year, and also for expected wealth [management] growth for the year,” she says.
To Wong, Trump trade wars are nothing new. “We’ve always talked about [geopolitical] uncertainties when Trump had his first term.”
In 2022, OCBC refreshed its corporate strategy to capture intra-Asian trade and investment flows. “The more trade conflicts there are, the more Asia will trade with Asia. It fits very neatly into our corporate strategy, capturing more corporate clients or SMEs in the supply chain under China+1 and China+N,” Wong adds.
In some perverse way, Trump’s trade wars may benefit Singapore. “We talk more about China plus N because Chinese companies are not just going to one country; Chinese companies are doing a lot more in the region. Some go to Indonesia, but everybody comes to Singapore first to set up their headquarters before travelling to the region. They always use Singapore as the centre to manage their investments in Indonesia, Malaysia, Vietnam, etc. That is how we have seen flows coming in and benefitting our corporate strategy. Geopolitical tension will be more fierce. I think that’s good for us,” Wong retorts.
Better for banks till it’s not
In sum, the Trump regime will be more inflationary, says Gupta. “It is possible that Fed monetary policy might stay tighter than is currently being projected. And, if rates stay higher, that helps our net interest income and NIM and might be reflected as we reprice our fixed asset book. The way the yield curves are, we might get better fixed asset repricing, which would help our overall interest income,” Gupta elaborates.
A potentially higher interest rate environment is “generally better for DBS”, says Gupta, even though the bank has not forecasted strong loan growth next year, at around 4%–5%. “Sensitivity shows that we benefit more from the interest rate than we give up on the balance sheet.”
United Overseas Bank’s (UOB) deputy chairman and CEO Wee Ee Cheong said, at the bank’s 3QFY2024 results briefing on Nov 8, that it was too early to tell when it came to revising the bank’s NIM guidance after the results of the election. While it seems that interest rates may remain higher for longer, the bank would prefer not to make any assumptions for now, he added.
Wee noted, however, that Asean remains a bright spot within the global economy and that the bank is poised to benefit from it. “Asean’s growth story is our growth story,” he says. “We are uniquely positioned to capitalise on the tailwinds of strong mega trends with our extensive regional network and capabilities.”
UOB’s management is banking on Asean to drive the banking group’s growth. As Wee says, Asean demand “boosted our loan books”. He has already articulated that Asean trade demand is a tailwind for UOB’s aspiration to be the Asean trade financing bank of choice.
The rise of the digital economy, with companies upgrading their systems and growth, and the green economy with transition finance and the shift to renewable energy are other areas that UOB is looking to boost loan growth and fee income from the advisory.
In 2011, UOB set up its Foreign Direct Investment (FDI) Advisory, expanding offices in North Asia, Southeast Asia and Mumbai. More recently, it opened a German FDI Advisory office as German and European companies seek growth outside the US and Europe.
“Synergies from our Citigroup acquisition have kicked in. Our customer base in the region continues to grow. Cross-sell synergies are bearing fruit, notably current account savings account (Casa) growth penetration across all four markets, and we will continue to focus on this,” Wee says. For instance, deposits grew by 2.5% q-o-q, outpacing the 2% q-o-q loan growth, leading to a dip in the loan-to-deposit ratio to 82.3% from 83.4% a quarter ago. More than that, Casa grew by 7% q-o-q and 17% y-o-y. In 3QFY2024, the Casa/Deposit ratio was 53.6%.
Upgrading the calls
Citi Research analyst Tan Yong Hong upgraded his call on DBS to “neutral” from “sell” previously, noting that the bank and the overall sector “re-rated sharply” on Nov 7.
He reasons that this is likely due to the “rapid shift” in rates expectations with rising bond yields, a spillover in optimism from the strength seen in US banks and DBS’s share buyback plan.
Tan previously downgraded all three Singapore banks, DBS, OCBC and UOB, to “sell” on Aug 5 after an increase in the expectations of US rate cuts. “Our bearish view on the sector is premised on rapid cuts in USD rates alongside softer sentiments impacting fees,” Tan explains in his Nov 7 report.
This time, the analyst sees a trio of tailwinds driving the sector’s re-rating, including a rapid shift in rate expectations with rising bond yields for the US two-year and US 10-year treasuries. A spillover in optimism from the strength seen in US banks and DBS’s $3 billion share buyback programme have also contributed to the positive sentiment.
“While our US economist continues to expect soft macro data leading to steep rate cuts, that could change with inflationary pressure from a second Trump administration and short-term rates have rebounded,” Tan writes.
In a Nov 10 report, Tan upgraded his call on UOB to “buy” with a higher target price of $40 from $29. He expects UOB to tap into its $3 billion excess capital to declare a special dividend of 25 cents per year in FY2024 to FY2025, similar to FY2017 and FY2019.
He notes that UOB could be the “next capital management play” among the three Singapore banks. In his view, UOB’s higher Common Equity Tier-1 (CET-1) ratio was the “key surprise”.
Tan notes that after implementing post-Basel III reforms, UOB’s capital position strengthened, with a higher CET-1 ratio of 15.5% as of Sept 30. From September 2023 to June this year, the bank’s CET-1 ratios have hovered around the 13% mark.
“[UOB’s] uplift to CET-1 ratio [has been] fully phased in driven by harmonising of risk-weighted assets (RWA) density across peers, on a fully phased in basis,” he writes.
With its CET-1 ratio now more in line with its peers, UOB can utilise 1% of its excess capital, implying an excess capital stock of $2.8 billion. Tan suggests multiple scenarios for capital management (which may not necessarily materialise), including quarterly distributions going forward, special dividends over the next three years, a “chunky” dividend per share (DPS) for the 4QFY2024, or a “sizeable” share buyback plan.
Tan has also upgraded OCBC to “neutral” with an increased target price estimate of $15.80 from $13.70.
OCBC’s 3QFY2024 ended September profit stood ahead of the consensus estimate by 3%, driven by non-customer trading income. OCBC’s trading income was driven by exceptional non-customer flow, which doubled on a q-o-q basis. In FY2024, Tan expects to see a “muted” upgrade due to higher-than-expected trading income in 3QFY2024.
As such, the analyst has raised his FY2024–FY2026 earnings estimates by 1%–4%, driven by higher trading income (higher rates volatility benefitting customer-related- and non-customer-related-flows) and reduced NIM sensitivity after increased positioning in hedges. “On capital management, we raise our DPS forecast, expecting an FY2024 final DPS of 46 cents, representing a 53% payout ratio for FY2024,” Tan writes.
“We see OCBC raising its DPS semi-annually through FY2026, implying [an] FY2025 payout ratio of 59%, FY2026 of 62%,” he adds.
UOB Kay Hian analyst Jonathan Koh has maintained his “overweight” call on the banking sector as OCBC’s and DBS’s 3QFY2024 results surpassed his expectations.
Koh’s top pick among the banks is OCBC due to its focus on Asean, followed by DBS. He has “buy” calls on both, with target prices of $46.95 and $21, respectively.
Citi’s Tan prefers UOB, OCBC and DBS in that order.
