Be on heightened alert for higher interest rates, says UOB Kay Hian Research analyst Jonathan Koh, recommending “overweight” on the Singapore banking sector.
Interest rates would be on an upcycle after quantitative easing (QE) taper is completed by March 2022, he adds.
“Our analysis indicates that every 100bp rise in 3M SIBOR results in net interest margin (NIM) expansion of 25bp for DBS, 13bp for OCBC and 16bp for UOB,” writes Koh.
The UOB Kay Hian analyst raises earnings forecasts for DBS and OCBC by 6% and 3% respectively for 2023 and expects earnings growth of 16% and 10% in 2024.
Koh is recommending “buy” on both DBS with a target price of $40.28, and OCBC with a target price of $16.12, with a 2023 dividend yield of 4.5% and 4.8% respectively.
Banks here will benefit from NIM expansion starting 4Q2022, says Koh.
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Interest rates in Singapore are highly correlated with those in the US. His regression analysis indicates that every 100bp rise in US FED Funds Rate results in 3M SIBOR increasing by 66bp.
Koh highlights the political dimension of monetary policy. “The Biden Administration is vigilant and is focused on taming the trend of rising inflation as a top priority. President Joe Biden launched the supply chain task force in June 2021. He has also repeatedly stressed the independence of the Fed to manage inflation effectively.”
“Many voters see inflation as the biggest problem confronting the US economy. Democrats are also concerned that high inflation could become a toxic topic during the midterm elections in November 2022,” he adds.
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In addition, elevated inflation could be prolonged by the Omicron variant, says Koh.
US core Personal Consumption Expenditures (PCE) inflation jumped 2.7ppt y-o-y to 4.1% in October 2021, the fastest pace in 30 years, overshooting the Fed’s target of 2.0%.
Implied inflation based on five-year Treasury Inflation-Protected Securities (TIPS) rose 1.6ppt y-o-y to a peak at 3.2% in November 2021 before receding to 2.7%.
“The Covid-19 pandemic disrupts supply chains by causing shortage of components, shortage of workers and port congestion. Thus, the emergence of the Omicron variant could continue to disrupt supply chains and prolong the current elevated inflation,” writes Koh.
Interest rates are on a gentle upcycle, says Koh. Based on projections by Federal Open Market Committee (FOMC) participants, the median projected path for Fed funds rate is 0.9% at end-2022, 1.6% at end-2023 and 2.1% at end-2024, which implies three interest rate hikes in 2022, three in 2023 and two in 2024.
UOB Global Economics & Markets Research expects 3M Singapore Interbank Offered Rate (SIBOR) and 3M Swap Offer Rate (SOR) to reach 1.15% (+71bp) and 1.10% (+74bp) respectively by end-2022.
Singaporeans overcame vaccine hesitancy and are well adapted to living with Covid-19 as an endemic, writes Koh.
Singapore is likely to keep the economy open and refrain from imposing another circuit breaker, adds Koh. “While the Vaccinated Travel Lane (VTL) scheme has been scaled down temporarily, we expect the reopening of borders with expansion of capacity for existing VTLs and introduction of new VTLs to resume in 2H2022. Singapore has to weather a new wave of Omicron variant infections in 1Q2022 but economic recovery is expected to likewise resume in 2H2022.”
As at 2.21pm, shares in DBS are trading 47 cents higher, or 1.14% up, at $33.71, while shares in OCBC are trading 10 cents higher, or 0.86% up, at $11.68.
