Impending rate hike may prick bond bubble

The US Federal Reserve is widely expected to lift interest rates later this year, which could spark an exodus of funds from Asia to the US.
The US Federal Reserve is widely expected to lift interest rates later this year, which could spark an exodus of funds from Asia to the US.PHOTO: REUTERS

Move could lead to investors selling bonds and chanelling funds into US

THE expected hike in interest rates in the United States could inflict some pain on bond markets, according to market watchers here.

They expect rates to start rising later this year, a move that could spark an exodus of funds from this part of the world to the US.

Phillip Futures investment analyst Howie Lee said that an increase in US rates will translate to higher yields on bonds and, in turn, lower bond prices.

This means that investors could sell their bonds and channel the funds into the US market instead, while "capitalising on higher rates and the rising greenback".

"Bonds have been inflated since the era of the zero interest rate policy in the US, and there is a real fear that the perceived bubble in bonds may soon burst," added Mr Lee.

Mr Hartmut Issel, head of equity and credit for the Asia-Pacific region at UBS Wealth Management, noted that government bonds are likely to "face a sustained period of subsequent underperformance".

High-yield bonds, on the other hand, "should do well" as the credit risk component shrinks, he said.

"A Federal Reserve that expresses confidence in the economic outlook by taking the first rate step is good news in this regard," said Mr Issel, who thinks the US Fed will make its first rate hike in September.

"It implies lower actual default rates than what markets are currently pricing in," he said.

"Thus, their perceived risk is declining while they still pay handsome coupons to investors."

Asian high-yield bonds could be a bright spark for investors, with a yield of close to 7 per cent, said Mr Issel.

"Credit spreads have yet to fully normalise after the turmoil earlier this year, when we had an isolated credit event that led to a sell-off in the entire sector," he said.

The expectation of rising interest rates means that the Singapore Savings Bonds (SSB) - to be launched in the second half of this year - could prove an attractive investment, said Mr Lee.

Interest on the SSB will be linked to long-term Singapore Government Securities (SGS) rates.

The 10-year SGS has yielded mostly between 2 per cent and 3 per cent during the past 10 years.

"They not only provide higher yield than fixed deposits, but are guaranteed by the Government," said Mr Lee.

He added that the SSB carry less risk, compared to corporate bonds.

With more details on the SSB yet to be finalised, however, Mr Issel cautioned that it is "still early days" to assess whether the bonds will provide investors with a hedge against rising interest rates.

"To the extent that they would predominantly come with floating-rate features, this would immunise them against further rising rates. But it is too early to make an assessment at this stage," he said.

Mr Lee added: "The last thing that investors should do is to engage in panic selling.

"All markets go through boom-and-bust cycles, and investors must learn to ride with the ups and downs of the market if they are to derive fruits from their bond holdings."

tsjwoo@sph.com.sg