Overview
“…growth of economic activity has slowed from its strong pace in the third quarter…Inflation has eased over the past year…” FOMC Statement, 13 Dec’23
Investors celebrated Federal Reserve’s dovish Dec 2023 statement by extending the November 2023 bond rally, with 10-year US Treasury yields dropping to circa 3.9%.
The Fed’s dovish dots
The updated dot plot signal 0.75% rate cut in 2024, while the market (futures) is signaling 1.50% rate cut in 2024, which seems to be a tad too aggressive.
Figure 1: Markets are expecting faster rate cuts than US Federal Reserve dot plot
Fed chair Powell warned of the risk of holding rates high for too long causing economic damage and excessive job losses. As seen in 2023, the monetary policy transmission has “long and variable lags”. Hence, Fed will continue to be data dependent – which will determine the pace of rate cuts, and is unlikely to pre-emptively cut the interest rates without a significant slowdown in economy. It is likely to err on the side of easing too late, rather than too early, to negate the risk of restoking the inflation it worked so hard to contain.
While inflation is gradually decreasing, the final descent to the 2% level is unlikely to be smooth, given genesis in sticky services inflation.
10-year UST peaked at above 5% in Oct 2023, highest level since 2007
- Source: Silverdale, Bloomberg, Dec 2023
Figure 2: Private sector job growth (‘000s, seasonally adjusted)
The unemployment rate is expected to move to 4.1% in 2024 from 3.7% in Nov’23. However, the labor market also continues to be resilient, with non-farm payrolls coming in at 199,000 for Nov’23. Also, the average hourly earnings are still rising at 4% annualized.
China gently pushing economic growth
Moody’s cut its outlook on China to negative (from stable) while holding its A1 credit rating, citing persistently lower mid-term economic growth (2024 est.: 4%) and higher contingent liabilities increasing debt at central government level. Credit flows have been mainly into strategic industries such as electric vehicles, batteries, and renewable energy, but away from real estate. The policy support continues in drips.
Yields still very attractive
Even after 2023-year-end rally, the bond yields continue to be very attractive relative to the recent past (See Fig-3). For example, in 2018, the US Fed rates were 2.5%-2.7% versus 2023-end rates of circa 3.8%-4.2%.
Figure 3: US Treasury rates remain attractive
- Source: US Bureau of Labour Statistics, BofA Global Research
Due to Local government financing vehicle (LGFV) debt risks and central government support to stressed regional and local government
Cash stockpiles could sustain momentum
At 2023-end, US Money Market Funds held a staggering US$ 5.7 trillion of AUM, marking the highest level on record. Given the Fed pivot, these investors are poised to start deploying idle cash for fear of missing out on potential upside, particularly in fixed income assets.
Figure 4: A huge amount of cash on the sidelines to be deployed
While the supply of new bonds (funds raised to refinance the bond maturities) in 2024, is likely to continue to be below long-term average, further putting downward pressure on bond yields.
2024: The politics of rate hikes
In 2024, elections will re-shape 40% of the world’s population and impact 60% of the global GDP. Commencing with Taiwan in January, India in April, the UK in autumn, and the US in last quarter.
Elections historically induce market volatility, particularly in the US, they may also signal fiscal expansion as incumbent governments strive to bolster support. The political and geopolitical risks embedded in elections and their associated transition of power, trigger market gyrations.
Sweet spot: Investment Grade 3-5 year
The current interest rate curve is inverted (with shorter term rates being higher than longer term rates). As the curve normalizes, the short-term interest rates are expected to fall, rather than long term interest rates going up. Investment Grade 3-5 years maturity bonds are in the sweet-spot because they are offering one of the highest yields since 2008 GFC, with potential capital gains as the yield curve normalizes (rates come down), resulting in potential high single digit returns. In case of spread widening and/or rates increase, the carry could cushion the impact and still result in positive total return for 12-months; further in case of significant spread widening, signaling economic recession, there is likely to be flight to safety benefiting the higher quality Investment Grade bonds.
Figure 5: US Investment Grade 3-5 Yrs Total Return over 12 mths
At yield of 4.9%, Int rate -1%, Spread +0.5%, total return = 6.7%
- Source: Silverdale, Bloomberg, Dec 2023
- Source: BofA, Dec 2023
December and 2023 Performances
For December 2023, the Bloomberg Emerging Markets Asia Total Return Index returned 3.6% and the Bloomberg EM USD Corp and Quasi 1-3Yr Index rose 1.8%. While the Silverdale Bond Fund NAV increased by 3.5%, and the NAV for various Silverdale Fixed Maturity Funds increased between +1.2% to 4.7%. The flagship Silverdale Bond Fund remains well-positioned to take advantage of the prevailing high carry offered by high-quality bonds, holding 76% Investment Grade bonds, with a duration of 2.15 years, yet offers a leveraged YTM of 10.6%, pointing to higher potential returns.
The investors who prefer higher assurance of returns versus potential capital gains, would do well to lock-in the current prevailing high yields through Fixed Maturity Funds.
As always, we are grateful to you for your support and wish you a happy and prosperous new year.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR DECEMBER 2023. This document is written for the benefit of and is being communicated exclusively to Accredited Investors or Institutional Investors as defined under the Securities and Futures Act (Cap. 289) of Singapore. The above commentary does not provide a complete analysis of every material fact regarding the market, industry, security, portfolio, or any Silverdale fund. It is not a recommendation to buy or sell any security nor an investment advice. The portfolio holdings, opinions and information may change without notice and the actual results may differ from the said opinions and estimates. The contents of this document, including any narrative, does not constitute an offer to sell or a solicitation of any offer to buy the units or any Sub-Fund or class of the Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational purpose only. The distribution of the shares of the Fund may be restricted in certain jurisdictions. It is the responsibility of the person or persons in possession of this communication to inform themselves of, and to observe all such restrictions, all applicable laws, and regulations of the relevant jurisdiction, including of any applicable legal requirements, exchange control regulations and taxes in the countries of their respective citizenship, residence, and domicile. Any subscription for units or shares must be made solely based on the Fund’s private placement memorandum, applicable class supplement) and Subscription Documents (together “the Offering Documents”). Past performance is not an indicator of future performance. The Fund uses leverage and invests in financial derivative instruments. Please refer to the Offering Documents for Risk Factors. Nothing in this document is intended to constitute legal, tax, securities or investment advice or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please seek opinion from an independent professional adviser before taking any decision based on this document.
- Source: Silverdale, Bloomberg – US IG 3 to 5year Index, Dec 2023