While there have been multiple wars and conflicts in the past two decades with severe humanitarian implications, these have been contained geographically, with minimal spillover impact on financial markets.
Beyond the humanitarian impact, the Russia-Ukraine conflict has had a broad second-order impact, with likely impacts to supply chain disruptions and its inflationary impact on economic growth and knock-on effects on the geopolitical stability in regions unable to substitute their food and energy sources.
We take some time this month to update our views from what we shared at the beginning of the year and look at what this means for corporate credit.
The US still going ahead with monetary policy tightening though pace of this is the main focus
At the beginning of the year, we highlighted that investors would need to contend with the continuing threat of higher inflationary expectations on one end and the looming possibility of a policy misstep that leads to a financial market pullback, which may happen should the market views that the rate rises and tightening are happening too quickly.
Since then, we think that the Fed is in an even trickier situation than before the conflict escalation to balance the potential impact of its policy tightening and an economic slowdown. This is especially the case as the previously expected inflationary pressures were largely supply-led and even more so now.
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The US Federal Reserve Board’s present core concern is domestic inflation where it is under pressure to ensure that inflation does not become a runaway problem — a situation that can happen if inflation expectations become entrenched. Additionally, the Fed also needs to get back on its path of policy normalisation which had been thrown off course during the last two years of the pandemic. The ultra-loose monetary policy means a lack of headroom for the Fed to manoeuvre policy in facing the next severe downturn.
Earlier in the month, Fed policymakers led by Chairman Jerome Powell voted in an 8-1 majority for an increase in the key policy rate to a target range of 0.25% to 0.5%, the first increase since December 2018, and well within market expectations. Additionally, an announcement is likely to come as soon as May 2022 on the Fed’s balance sheet reduction plans. This was followed by rhetoric by several Fed speakers through March 2022 who have signalled support for a faster tightening. As of writing, the market is pricing in around eight rate hikes by the end of this year, indicating at least one rate hike at every meeting over 2022.
Prefer to take some credit risk over interest rate risk in the current environment
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While fixed income as an asset class is not a natural investment option in an inflationary environment, we expect income-seeking investors to continue holding a portion of fixed income in their portfolio and the next question is where to seek shelter within fixed income.
Given that the current predicament is mainly rates-driven with the economy still in a growth mode, the turmoil has mainly affected the rates sensitive part of the fixed income market. We observed that year to date, total returns on the iShares US Treasury ETF have fallen 6.8%. US treasuries are generally seen as nearly credit-risk free as implied by the sovereign credit rating of at least AA+. The US investment-grade corporate market has also been negatively impacted, with a corporate investment-grade ETF from the same provider having fallen 8.4% during this same time period.
Aside from the China property high yield sector, major corporate credit markets we look at are not showing signs of general credit stress. After a volatile December 2021 which spilt into early 2022 and a brief widening in the first half of March from the threat of higher rates and concerns of liquidity pullback, the rise in credit spreads in US investment grade, US high yield and Asiadollar investment grade has subsided and are still at the lower end versus historical levels.
That said, overall US issuances have notably fallen year to date compared to the same time last year. This was mostly driven by a lower volume of high yield papers as issuers are likely less keen to pay up for higher funding while pandemic-hit travel and hospitality issuers who had been issuing debt to finance operations and oil and gas issuers had a limited presence in the primary market so far this year.
With higher credit spreads and lower duration, we expect investors to continue their preference for high yield and crossover this year as investors seek shelter in pockets of the market that are less sensitive to rates. As a further contrast to investment grade, the US high yield market has only fallen 4.1% and looks to be gradually recovering.
However, within the Asiadollar space, we think it no longer pays to take a top-down allocation view on the Asiadollar high yield market. Several China high yield companies in this sector have announced that they are likely to miss deadlines for reporting their audited financial results due to reasons like a change in auditors and operational delays associated with the current Covid-19 outbreak. We expect investors to be selective in terms of country, industry sector and issuer-level credit risk exposure when it comes to Asiadollar.
Activity gradually returning to the Singapore corporate credit primary market
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The Singapore corporate credit market did not escape unscathed, with investor uncertainty hampering primary activity. However, the market saw two well-known issuers successfully pricing new issuances in the Singapore dollar credit market last week. Both priced five-year senior unsecured bonds.
Interestingly these two issuances were on both sides of the credit scale. One was a property company with large exposure to the hospitality sector that is making a large-scale acquisition while the other was an investment-grade company focusing on the postal and delivery business. These two issuers collectively raised $280 million.
As of writing on March 30, 2022, these two issuances alone represent 22% of the overall amount that has been priced year to date in the Singapore dollar corporate credit market. Indicative of a market still finding its feet, the investment-grade issuer came to market with wide initial price guidance, leading to a repricing downwards of similar tenor bullet bonds issued by its investment-grade peers. Ahead of results season for the first quarter of this year which starts in mid-April, we expect the issuance pipeline to be healthy and in a seemingly more adverse market condition, we are also starting to see dealmakers being creative in their structuring to bridge the gap between issuers and investors.
Singapore dollar corporate credit market as a relative safe-haven
Despite it being a largely unrated market, the overall quality of issuers within the Singapore dollar corporate credit market (and that of statutory boards) are resilient in our view.
Across our Singapore dollar corporate credit coverage that comprises mainly property developers, REITs, industrials and financial institutions, the largest proportion of around 40% of the issuers are rated neutral (4) according to OCBC Credit Research’s Issuer Profile scoring criteria which would broadly equate to being crossover credits on the international credit rating scale. Slightly more than a third of our total coverage is rated at even higher levels which we think would likely be considered as high investment grade if these were externally rated.
In addition to the composition of issuers, the characteristics of Singapore dollar corporate credit investors also provide relative stability to the price performance of bonds in the Singapore dollar corporate credit market. The market is mostly comprised of buy and hold investors with strong holding power. Some of this relates to the composition of issuers which are largely well-known issuers in Singapore that benefit from solid investor recognition and have dependable banking relationships. This can help stabilise the liquidity positions of Singapore dollar corporate bond issuers during volatile times which ultimately support the fundamental credit profile of issuers.
Ezien Hoo, Wong Hong Wei, Toh Su-N and Andrew Wong are credit research analysts at OCBC Bank’s global treasury research & strategy
