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Fed raises rates, but there is still plenty of liquidity

Bonds stay pricey with an expected low interest rate environment; stocks dip in tandem with oil prices
Friday, June 16, 2017 - 05:50

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Asian stocks fell slightly and bond markets continued to be buoyant even as the US Federal Reserve raised interest rates to the 1-1.25 per cent range on Thursday morning.

Singapore

ASIAN stocks fell slightly and bond markets continued to be buoyant even as the US Federal Reserve raised interest rates to the 1-1.25 per cent range on Thursday morning.

Observers said asset valuations can stay elevated because the liquidity unleashed by central banks after the global financial crisis is still very much in the global financial system.

The deflationary impact of technology and ageing populations might also contribute to a low interest rate environment for some time to come, they said.

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Paul Griffiths, chief investment officer of fixed income and multi-asset solutions at First State Investments, told The Business Times that asset prices continue to be propped up by central banks around the world.

"If you look at equity and fixed income markets, valuations are pretty high, yet at the moment it's hard to see what changes that," he said.

By hiking rates, the US is giving itself room to manoeuvre, he said, noting that in Europe and the UK, there is little room left to cut anything.

Bond-killing inflation is absent for now, but Mr Griffiths is closely watching for signs in wage and production data. "Once inflation gets into an economy, it takes a gargantuan effort to crush it out of the system. Expectations of wage increases become a circular argument."

Desmond Soon, head of investment management for Asia ex-Japan at Western Asset Management, said that "the wall of liquidity underpinning global assets including physical real estate is unprecedented and not going away soon".

Although the broad market is expensive, weak companies and poorly-managed ones in challenging industries can still fail, he added.

"Not all credit will be lifted by 'strong technicals'. As such, we have avoided commodity issuers like Noble Group, Reliance Communications and Singapore offshore and marine bonds."

Arthur Lau, head of Asia fixed income at PineBridge Investments, said lower US inflation data has led to more investors buying longer-dated, interest rate-sensitive assets.

"We believe Asia rates generally will follow the US, but given the ample liquidity in the system, we would expect the pace of rate rises to remains gradual. We do not expect significant asset repricing in Asian bond markets in the short term."

Kelvin Tay, UBS Wealth Management regional chief investment officer for the southern Asia-Pacific, said the weakness in Asian and Singapore stocks on Thursday was mainly due to oil prices falling to its lowest levels since November 2016.

With higher rates expected, the current recovery in the Singapore property market might be modest at best, he added.

"With the Chinese economy moderating and Asian exports showing signs of moderating from the first quarter's stupendous recovery, any hope of a significantly stronger showing from the Singapore economy is likely misplaced."

The Fed's latest hike was its second this year and the fourth since the current hiking cycle began in December 2015. On average, Fed members have forecast another hike for the year and another three in 2018. The Fed has also laid out plans for reducing the size of its balance sheet later this year.

BlackRock global fixed income chief investment officer Rick Rieder said the Fed move was fully justified, considering how monetary policy is supposed to be forward looking.

But Citi dubbed the Fed's move a "hawkish hike" given weak US retail sales and inflation data.

Until inflation picks up, US yields are likely to be capped, and the US dollar not likely to spike. Emerging markets and longer-dated bonds can still perform, Citi said.

Roger Early, global co-head of fixed income at Macquarie Investment Management, said the view that inflation will return is challenged by high levels of debt in the developed world, ageing populations and declining productivity. In the US bond market, riskier high-yield bonds are expensive relative to investment-grade bonds, he said.

He suggests conservative non-US based investors buy US taxable municipal bonds, which yield 0.25-0.3 percentage point more than their equivalent A-rated corporates while having a lower historical default rate. Mortgage-backed securities issued by government-sponsored agencies also offer opportunities, he added.

Sarah Lien, client portfolio manager at Eastspring Investments, said Asian equities continue to offer good value, liquidity and income even with a modest rate hike cycle in the US.

Stocks in Singapore are favoured for the Eastspring Asian Equity Income Fund, she said. They comprise a mix of ports, industrials, real estate investment trusts, telcos and banks.

"We find strong valuation signals and robust dividend yields in the Singapore market."

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