Victor Yong [email protected]

Global Economics & Markets Research Email: [email protected] URL: www.uob.com.sg/research

Monday, 28 August 2017 Rates Insights

15Y SGS Auction this Week. Favor Early Roll into New Benchmark

Market Summary  Over the past week, 3M SOR increased by 11.3bps, 3M SIBOR increased by 0.3bps and 3M LIBOR increased by 0.3bps.

 The 1M vs. 6M SOR curve flattened by -10.5bps and the 3M SOR vs SIBOR spread widened by 11bps.

 10Y SGS has underperformed vs. UST and outperformed vs. SG IRS. The 10Y SG IRS yield increased by 3.7bps, which was less than 1 std dev based on historical yield changes over the past month.

 The 5Y vs. 30Y SG IRS curve closed today at 0.82% and has flattened by -0.5bps over the past week.

1 Week Benchmark Yield Changes SG IRS Weekly Yield Change Relative To 1 and 2 Standard Deviation Bands 0.08 0.20

0.04 UST 0.10 %

SGS % 0.00 0.00 IRS -0.10

-0.04 -0.20 2Y 5Y 10Y 30Y 2Y 5Y 10Y 15Y 30Y

Source: Bloomberg Source: Bloomberg

10Y SG IRS 2s10s SG and US IRS Curves

2.30 0.94 0.58

2.25 0.92 0.56 2.25 0.55 % 2.20 % % 0.90 0.54 2.15 SG (lhs) 0.90 US (rhs) 2.10 0.88 0.52 31-Jul 7-Aug 14-Aug 21-Aug 28-Aug 21-Aug 22-Aug 23-Aug 24-Aug 25-Aug 28-Aug

Source: Bloomberg Source: Bloomberg

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Money Market Rates

Historical Historical Volatility 30D 90D 180D 30D 90D 180D Annualized (%) Annualized (%)

1M SOR 102.7 109.0 115.3 1M SIBOR 2.0 26.1 22.0

3M SOR 84.7 78.6 69.3 3M SIBOR 2.6 13.1 13.3

6M SOR 51.4 49.1 40.9 6M SIBOR 0.5 0.6 4.1

Tighter funding into month end The month end turn and this week's holiday shortened week have provided an additional boost for SG funding rates over and above the progressive draining of liquidity via upsized MAS bill issuances. Price action over the past week has consisted of yield spikes in overnight SGD deposit rates and SOR curve flattening, which when overlaid on the calendar, is more suggestive of a transitory pricing dynamic rather than a structural re-pricing taking place. Indeed when we survey the indicators of changes in FX sentiments, the negative USD sentiments remain firmly in place. SGD NEER has strengthen in the past week and USDSGD risk reversals and have both drifted lower. Therefore, conditions for a negative feedback loop of domestic currency depreciation and higher domestic interest rates are absent. This being the case, we see 3M SOR settling back under 1.00% when funding market normalize since the SGD NEER continues to be supportive of a USDSGD FX discount.

Transitory factors aside, the underlying liquidity management trends favours an upward trajectory in SG rates. In addition, seasonal performance in USDSGD FX swaps over the past 10 years has on average favoured tighter SG vs. US yield differentials. Finally, given the prevailing location of SGD NEER versus its midpoint, the scope for upside (currency strength) is lower compared to the downside (currency weakness). Taken together, the risk for SORs is looking increasingly asymmetric and we would favour paying the forwards or short dated IRS when they undershoot while correcting for transitory effects.

Rate normalization expectations at year to date lows Although implied probability of a FED hike for December managed to close the week higher (37.4%) than where it started (32.3%), pricing for rate hikes further out in time has fallen to its lowest levels this year. The Eurodollar curve 4th vs. 8th contracts is priced for only 1 hike and this curve has only been recently flatter during the peak Negative Interest Rate Policy (NIRP) days of 2016. This is a rather surprising outcome given the differences in monetary policy expectations then compared to now. The prevailing curve is suggestive that investors may be contemplating the scenario of monetary policy misstep and a possible volte face by policy makers. Based on our macro team's forecasts, we think that the market may have set the monetary policy expectations bar too low and that the potential for higher rates is currently under-appreciated.

Short term view: * 3M SORs looking to carve out an equilibrium around 0.90%. Prefer to fade SORs (USDSGD FX swaps) under 0.70%. * US Libors to continue their grind higher with 1 more hike in 2017 expected (December). Upside risk could come via unintended USD funding stress as a result of FED's Balance Sheet reduction program (September).

Daily changes in 3M SOR Attributed UOB SGD NEER Deviation From Mid Point 8.0 6.0 0.80 1M USDSGD risk reversal… 1.4 0.70 SGD NEER deviation (rhs) 4.0 0.60 1.2 0.50 0.88 2.0 FX Swap 1.0 bps % 0.40 % 0.0 0.30 0.8 Libor 0.20 -2.0 0.6 SOR 0.10 0.00 0.4 -4.0

11-Aug 14-Aug 15-Aug 16-Aug 17-Aug 18-Aug 21-Aug 22-Aug 23-Aug 24-Aug Source: Bloomberg Source: Bloomberg

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Bonds and Interest Rate Swaps

Asset Swap Spreads

SGS Benchmark Tenor Current T - 1 T - 2 T - 3 T - 4 T - 5

SIGB 2 1/2 06/01/19 2Y -0.6 -0.8 -0.3 -0.6 -3.4 -2.4

SIGB 1 3/4 04/01/22 5Y -13.2 -12.7 -13.3 -13.6 -15.8 -16.2

SIGB 3 1/2 03/01/27 10Y -7.5 -7.0 -6.1 -6.0 -6.6 -6.6

SIGB 2 7/8 09/01/30 15Y -6.4 -5.9 -5.6 -3.7 -4.5 -4.7

SIGB 2 1/4 08/01/36 20Y -12.3 -11.7 -10.0 -9.4 -9.0 -9.3

SIGB 2 3/4 03/01/46 30Y -12.3 -13.1 -11.9 -6.6 -10.2 -7.1

Speculative positioning favours yields lower for longer Updated positioning data from CFTC points towards increased longs in 10Y UST and a slight decrease in shorts on the Eurodollar contract, which translates to speculators remaining comfortable with the theme that US yields are going to stay lower for longer. Political headlines on tax reforms have not significantly altered perceptions in the rates markets, instead investors here may be more concerned that the upcoming US debt ceiling debate might be a messy one which could induce episodes of flight to quality. Beyond politics, pricing for FED balance sheet reduction risks is arguably too sanguine when 10Y US term premium is at -30bps, just 10bps shy of year to date lows of -40bps. The UST term premium curve is similarly closer to its year to date lows at 14bps (low of 6bps in June).

10Y UST expecting year to date lows to hold In the absence of a deeper breakdown in risky assets, i.e. equities and FX carry trades, we expect the year to date low in 10Y UST to survive a potential test in the near term. US non-farm payrolls on Friday should also serve as a moderating force against investors' sentiments turning sharply negative before the event risk given that employment numbers have been printing on the firm side. Tactically, we are more comfortable with buying price dips unless 10Y UST can take out the short term downtrend line at 2.25% convincingly. Although our base case expectations are for the year to date lows to hold, shorting the 10Y UST at current levels will have to be paired with tight stops.

2Y SG bondswap spread asymmetric risk Tight funding has caused the SGS curve to underperform the IRS curve. 2Y bondswap spreads have crossed the parity threshold and the scope for further tightening looks limited. Since 2000 the 2Y SG bondswap spread has only been tighter than current levels on 8 previous days, all of which were recorded during the brief period in 2010 when SORs went negative. SORs have begun to show signs of being more responsive to domestic liquidity conditions thus further outperformance versus MAS bills may become more muted. In addition, we also see potential from seasonal tailwinds in the USDSGD FX swaps that will help the 2Y bondswap spreads mean revert wider. Therefore, we favour being long the October 2019 SGS against paying 2Y SGD IRS at -3bps, stops at -13bps, to target 20bps by the end of the year.

Short term view: * 10Y UST 1 week expected range 2.10%/2.25%. * 10Y SGS 1 week expected range 2.05%/2.20%.

Bond Yield Curves as at 28 Aug 2017 SGS Spread Curve 3.00 2.75 10 5 2.17 2.50 0 1.76 2.00 2.47 -5 SGS bps ASW (-1week) % 1.33 2.13 -10 1.50 UST -15 ASW (current) 1.59 -20 1.00 1.29 0.50 2Y 5Y 10Y 30Y

Source: Bloomberg Source: Bloomberg

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The Next SGS Auction Size 15Y SGS re-open Next Auction: Announcement Tuesday, 22 August, 2017 01 Sep 2033 (NZ13100V) Date: Auction Date: Tuesday, 29 August, 2017 Auction Size: T.B.A

Results from previous 15Y SGS auctions (2010 to date) * Max auction size: SGD 2.2 bio. Min auction size: SGD 1.1 bio. * Re-open only average auction size: SGD 1.3bio. Max/Min: SGD 1.6bio/1.1 bio. * Weighted average Bid to Cover: 1.84 times, Max B/C: 2.14 times, Min B/C: 1.65 times. * Re-open only average bid to Cover: 1.92 times, Max B/C: 2.14 times, Min B/C: 1.65 times.

Next month's 15Y re-opening will be the last supply of duration this year if October's mini-auction was not exercised for a longer re-open. Our subjective probability for the mini auction is a 60% chance that it will be triggered for a re-opening in the greater than 10 year tenors. SGS duration supplied to date has not been overly generous thus there is still headroom for demand to absorb another long maturity re-opening. In addition, yield curve flattening dynamics due to benign inflation expectations and the persistent search for yield means that the back end of the curve can still be expected to outperform on average when overall yield levels are rising in a moderate fashion.

15Y auctions have historically been sized on the conservative side, there was only 1 instance where supply was above SGD 2bio over the past 5 auctions and that was for a new issue. Re-opening sizes have ranged between SGD 1.6bio and 1.1bio which reflects a historical tendency for 15Y demand to be poorer than either the 10Y or 20Y tenors. This can be observed directly through the differences in bid to cover ratios as well as from the persistently cheaper 15Y ASW compared to its wings on the secondary market. We expect the upcoming re-open of Sep 2033 to be sized in line with historical ranges.

The outright ASW curve is significantly cheaper compared to where it started out the year. This has been due to SORs drifting lower despite 2 FED hikes this year driving outperformance in the swaps curve. In contrast, SGD funding costs have remained largely stable for most of the year and has recently started to re-price higher which does not materially enhance the carry profile of SGS. However, there are limitations to how much cheaper ASW can go especially in the longer end of the curve where mark to market effects outweigh interest accruals. Sep 2033's ASW has been cheapening along a 45 degree line since the middle of February and as at the end of July is close to parity as well as being the cheapest levels this year. On this measure, there is minimal concession pressure on Sep 2033 going into next month's auction. We favour capturing any positive ASW to benefit from eventual mean reversion.

Sep 2033 underperformed the 5 and 30 year benchmark SGS during the recent synchronized bond re-pricing caused by hawkish rhetoric from a few developed market Central Banks, and outperformed as enthusiasm for globally higher yields waned. This sensitivity by Sep 2033 to yield spikes looks likely to remain intact for the next month, especially with the added weight of supply looming. We are biased towards better upside potential in both the 5s15s30s SGS as well as the 10s15s SGS curvature leading up to auction.

Source: Bloomberg Source: Bloomberg

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Source: Bloomberg Source: Bloomberg

Auction Dashboard

Sep 2033 closing yield (%): 2.423 Sep 2033 ASW (bps): -3.8 Sep 2033 vs 15Y UST (bps): 15.4 5 v (Sep 2033) v 30 SGS (bps): 78.5

Weekly Change (bps): 1.7 Weekly Change (bps): -2.1 Weekly Change (bps): 3.4 Weekly Change (bps): -4.9

Last Tuesday (22nd) MAS set the re-opening size of Sep 2033 auction at SGD 1.3bio. This was inline with our expectations and spot on with the middle of 15Y auctions since 2010. We are rather agnostic about the size and based on the price action last week, it would seem that Primary Dealers (PDs) on average were also not too concerned. Sep 2033 was marginally richer on both the 5s15s30s SGS butterfly, going from 83.5bps down to 79.25bps, as well as asset swap spreads, going from -1bps to - 3bps, as of Friday's close of the week. The overall SGS curve underperformed the UST curve, but here too the 15Y tenor was not the laggard. It therefore appears that PDs may have been prepared for a slightly larger re-opening size and were quick to cover some of their shorts ahead of the auction, particularly when the Sep 2033 is yielding close to its highest levels in a month.

Early rolls of the 15Y benchmark (i.e. switching out of the Sep 2030 into Sep 2033) continues to make sense to us given the 10bps of pickup on offer. Sep 2033 vs. 20Y SGS curve inversion deepened marginally from -1bps to -2bps last week but a tight cut-off yield at this week's auction could provide some respite as the duration pick up between the incoming 15Y benchmark and the 20Y benchmark is only a mere 3 years which makes it a high price to pay. Another factor potentially weighing against deeper curve inversion will be October's mini auction which we subjectively assign a 40% probability that it may be called for a second re-tap of the 20Y benchmark. If September's FOMC does flag off FED balance sheet reduction, it will probably be too early for unintended consequences to show up in the markets by 02 October, the mini bond announcement date. Investors sentiments towards holding duration and yield pick ups will likely remain supportive at that juncture if re-pricing to the balance sheet event occurred in a controlled fashion.

In a nutshell, we don't see this week's Sep 2033 auction changing the dynamics of flat SGS curve beyond the 10Y tenor. We favour opportunistically fading deeper inversions in the 15s20s curve from current levels of -2bps, since deeper dislocation will increase the odds of 20Y re-tap at October's mini auction. We also prefer to be receivers of the 10Y ASW spreads at current levels as the risk in SORs is asymmetric in favour of upside going into the end of the year.

Tactical 15Y auction bias * Our base case sees 15Y hovering between 2.30% to 2.50% into auction. Shorts preferred under 2.30% while longs will look attractive between 2.55% and 2.60%. * Underperformance vs IRS and UST applies across the SGS curve and is not a clean auction concession play. * Prefer to express auction concession via 10s15s SGS steepeners and/or 5s15s30s SGS butterfly.

Notes on 2017 SGS Cash Flows * March/September are chunky coupon months for SGS with SGD 646.1mio to be distributed. * February/May/August/November are dry months for SGS coupons. * No new coupons will be added to dry months in 2017. * Maturities for 2017 total SGD 10bio due in April (SGD 7.5bio) matured and October (SGD 2.5bio).

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Coupons for 2017 Maturity for 2017

800 3.0 2.5 600 2.0 400 1.5 1.0 200 SGDBillions

SGDMillions 0.5 0 0.0 January February Ma rch April May Jun e July August September October November December January February Ma rch April May Jun e July August September October November December

Source: Bloomberg Source: Bloomberg

Rates Biases Inception Date Currency Type Format Entry Stop Target Rationale at inception Risk for 2Y SG bondswap spreads Long are asymmetric. This spread has October - only been tighter on 8 previous 28-Aug-17 SGD Bondswap 2019 vs. -3bps 20bps 13bps occasions since 2000. SORs have pay 2Y started to show signs of being SGD IRS responsive to tighter SGD liquidity. Receive 10s30s ASW curvature is biased 30Y (Mar towards flattening after long end 2046) supply has been concluded. Next 2 29-May-17 SGD Flattener ASW vs. 9bps 18bps -10bps auctions are in the belly region and Pay 10Y will help support relative (Mar cheapness in the 10Y ASW. 2027)ASW Arguments for higher yields into 2017 are predominantly US centric. This being the case and in combination with our macro team’s lukewarm but not short 10Y recessionary growth outlook for SGS UST vs - Singapore, conditions are 3-Jan-17 SGD -1.5bps 30bps outperform long 10Y 20bps supportive of a lower beta SG rates SGS market response to US rates changes on average in 2017. Therefore we expect to see 10Y UST – SGS spread moving further into positive territory over the course of 2017. Trumpflation is expected to have negative implications on US deficit, which will drive a greater appreciation of duration risk and richer term premiums. For 2017 we expect to see the term 5s10s SG 3-Jan-17 SGD Steepener 48.5bps 40bps 70bps premium repriced to a higher IRS equilibrium level. From a SG rates market perspective, a steeper 5s10s IRS curve will be justified in the above scenario at least until the FED demonstrates a significantly more hawkish stance.

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Benchmark Levels Country Rates Current 1 week change 1 month change 1 year change 3M Libor (%) 1.32 0.00 0.00 0.49 2Y Bond (%) 1.33 0.03 -0.02 0.49 USD 10Y Bond (%) 2.17 -0.01 -0.12 0.54 10Y IRS (%) 2.09 -0.01 -0.13 0.69 2s10s Bond curve (bp) 83.6 -4.4 -10.6 4.9

3M SOR (%) - 0.11 0.15 0.27 2Y IRS (%) 1.35 0.05 0.09 -0.10 SGD 10Y IRS (%) 2.25 0.04 0.03 0.23 10Y Bond (%) 2.13 0.03 0.04 0.30 2s10s IRS curve (bp) 90.2 -1.6 -6.2 32.4

3M Klibor (%) 3.43 0.00 0.00 0.03 2Y IRS (%) 3.56 -0.01 -0.02 0.26 MYR 10Y IRS (%) 3.97 0.00 -0.03 0.24 10Y Bond (%) 3.92 -0.05 -0.07 0.37 2s10s IRS curve (bp) 41.5 1.0 -1.0 -2.0

3M Bibor (%) 1.58 0.00 0.00 -0.01 2Y IRS (%) 1.45 0.03 -0.13 -0.15 THB 10Y IRS (%) 2.26 0.04 -0.12 0.14 10Y Bond (%) 2.35 -0.02 -0.11 0.21 2s10s IRS curve (bp) 81.5 1.0 1.5 28.1

3M Jibor (%) 5.69 -0.32 -1.20 -1.44 2Y Bond (%) 6.16 -0.16 -0.27 -0.31 IDR 10Y Bond (%) 6.75 -0.11 -0.17 -0.28 2s10s Bond curve (bp) 59.6 4.5 9.8 2.7

Disclaimer: This analysis is based on information available to the public. Although the information contained herein is believed to be reliable, UOB Group makes no representation as to the accuracy or completeness. Also, opinions and predictions contained herein reflect our opinion as of date of the analysis and are subject to change without notice. UOB Group may have positions in, and may effect transactions in, currencies and financial products mentioned herein. Prior to entering into any proposed transaction, without reliance upon UOB Group or its affiliates, the reader should determine, the economic risks and merits, as well as the legal, tax and accounting characterizations and consequences, of the transaction and that the reader is able to assume these risks. This document and its contents are proprietary information and products of UOB Group and may not be reproduced or otherwise.

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Rate Insights 28 August 2017