SGD underperforms amidst extreme market conditions

RBS’ call on upcoming MAS’ policy decision – neutralize policy slope and/ or widen policy band symmetrically. Therefore, the key question now is whether the MAS would prevent the market from going overboard. This is as good as asking how the MAS would shift its policy mid-next month when it conducts its semi-annual policy review. Weighing the growth-inflation equation, we believe the MAS would shift to a zero appreciation policy and/ or widen the policy band symmetrically. It is very unlikely to implement a one-off depreciation this soon, in our view. Nevertheless, broadening the policy band – even in symmetrically – is a big step considering that the current band width has not been normalized to the pre-Lehman width after being expanded in October 2010. Furthermore, as the SGD NEER is now testing the weak end of the band, this latter option of a further widening of the band width has become a critical point. In watching the MAS’ actions in the next few weeks prior to the policy decision with the date as yet unannounced, we highlight three points as a guiding posts:

- Strength of foreign reserves. The MAS is fully equipped with USD249bn of cash reserves (as of end-July) and USD110bn of FX forward reserves (as of today based on our in-house estimates) to defend the SGD. Although the FX forward reserves have come off from a peak of USD124bn in August, the amount still puts the MAS stand it in good stead to use the unwinding of these forward positions to buffer the impact of the spot intervention on the short-end SGD interest rates. Vice versa, it also gives the MAS’ plenty of ammunition to keep up the spot intervention to defend the SGD band. Hence, don’t out-run the MAS unless you are betting they would do an outright depreciation by shifting the entire policy band downwards at one go. We assign very low odds on this scenario. Likewise, we see very low odds of a shift into a negative slope or depreciation policy which has never been done before in the history of MAS’ SGD policy since 2000 when the central bank began to publicly issue policy statements on a semi-annual basis.

- Option of inter-policy meeting. The MAS carried out an inter-policy move in October 2001 after the terrorist attack on the US. As the MAS is likely to focus on the more immediate concern for a contagion spillover from the EU crisis at the expense of the lingering inflation concern, the odds are high that the central bank will keep the open option of conducting a later inter-policy move, depending on the EU situation. It also means that the possible inter- policy move could have a binary outcome – a one-off depreciation or a return to an appreciation path.

- Early signal of policy intention. Decisions are usually approved by the MAS’ board at the end of each half-yearly review period i.e. the end of September for the upcoming mid-October meeting. If the decision is a significant shift, the MAS might choose to send signals to the market before the announcement. Hence, the resolve of the MAS’ intervention efforts in coming weeks might provide us some clues.

FX strategy: long USD/SGD 3m x 12m forward point. There were only three brief periods in the post-2000 history that the USDSGD FX forward curve had dis-inverted into positive premium – late 2001 (terrorist attack on the US), late 2003 to early 2004 (SARS epidemic in Asia) and late 2009 (global credit crunch). All three periods came about after the MAS made a one-off depreciation move combined with a switch to neutral policy stance. As we are not expecting that the MAS moves as aggressive as they did during those periods, we prefer not to turn long USD/SGD outright or buy the forward points too far out the curve. Hence, we suggest buy the 3m x 6m part of the USDSGD FX forward curve, targeting for it to dis-invert within the coming three months.

Rates strategy: switched from receiving in the belly (we suggested a 2y3y forward idea on 10 August which is 17bp in the money) to 2s5s flattener. Although rates especially on the front end are held hostage of FX in the 3-6 months, we would not suggest paying rates outright. The rationale is similar to that for our FX strategy – the MAS has a war chest of reserves to defend the SGD and the FX forward reserves to act as a natural sterilization buffer for the short-end interest rates as explained above. Hence, we do not expect the 6m SOR fixing to turn too positive. Also, SGD IRS curve is still steep relative to the region and the 2s5s curve is especially in comparison to the 1s2s curve.

Bond strategy: get ready to extend duration – buy Jun’21 10y benchmark on dips. Given that the impact of the impending policy shift will be felt most on the front-end rates, the fund outflows would likely be most pronounced on the short-dated SGS. Hence, we actually see the coming run-up in short-end IRS as opportunities to extend duration. There are three technical factors in support of extending duration risk. First, supply for the rest of this year will not favour the short end as the remaining scheduled auctions are on the 3y and 1y tenors. Second, the stronger correlation of SGS curve to US treasuries curve on the long end than the short end, the Fed’s Operation Twist to hold down the long-end UST yields would work in favour of the long-dated SGS. Thirdly, in swap spread term, long-dated SGS has underperformed the belly of the curve, especially since the start of this month.