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UOB ‘less enthusiastic’ on upcoming two-year SGS outperformance vs US Treasuries or Sora OIS

Felicia Tan
Felicia Tan • 5 min read
UOB ‘less enthusiastic’ on upcoming two-year SGS outperformance vs US Treasuries or Sora OIS
The two-year SGS, which matures on June 1, 2025, will be reopened on Feb 24 to the tune of $3.2 billion. Photo: Bloomberg
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UOB’s global economics and market research team as well as interest rates strategist Victor Yong is “less enthusiastic” on the outperformance of the upcoming two-year Singapore Government Securities (SGS) compared to the US Treasuries (UST) or the Singapore overnight rate average (Sora) overnight index swaps (OIS).

The two-year SGS, which matures on June 1, 2025, will be reopened on Feb 24 to the tune of $3.2 billion, making this the largest size for the two-year tenor bonds. The sum is also $0.6 billion higher than the last two-year auction in June 2022. This will be the fourth re-tap for the issue since it was first introduced as a 10-year bond in 2015.

After the auction, supply outstanding for June 2025 will increase to $11.7 billion making it the most liquid issue on the SGS curve, notes Yong and the team.

To Yong and the team, the “demand for the two-year tenor is typically rather inelastic due to how banks manage their regulatory reserves requirements”.

“In addition, short-dated Singapore dollar (SGD) funding markets have been behaving in a well-supplied manner, and there also continues to be retail interest in shorter dated cash management instruments,” they add.

“Bid-to-cover (BTC) for two-year SGS auctions have historically been anchored around two times. Despite the tenor’s record size, we will not be surprised if the BTC for Friday’s auction came in at the higher end of its range. Assuming prevailing yield levels hold into the auction, this will be the first time since 2007 that a two-year SGS auction will be sporting a 3% handle on its yield” continues the team.

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The way they see it, investors may put in money based on the understanding that the pace and the magnitude of the US Federal Reserve (US Fed) rate hikes will slow in 2023.

“Moreover, having seen economic growth slowing, investors’ rate bias will already be tilted positively. This suggests to us that the two-year SGS yield will be attractive enough for demand to step up to the plate on Friday,” says the team.

So far, the two-year SGS has recorded an outperformance compared to the US Treasuries and, to a lesser extent, against the Sora OIS.

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The bond due June 2025 closed at 3.39% on Feb 20 and is at its highest level since October 2022, notes the team.

“Although June 2025’s yield remains a distance away from its September/October high of close to 3.60%, we cannot rule out the possibility that the market may try to test this highwater mark. However, we do think that a significant break higher is a low probability scenario and would require a meaningful shift in the accompanying monetary policy narrative (e.g. +/-6% Fed funds becomes base case),” it writes.

“Gains in the two-year SGS yield is further flattered by the three-month Singapore swap offer rate (Sor) versus two-year SGS curve which has also steepened by 34 basis points (bps) in the past month,” adds the team.

To the team, the bond is “fairly priced” when it’s being referenced to the fitted curve.

To be sure, they recommend investors holding the current two-year SGS benchmark bond that’s due to mature in September 2024 to switch into the bond due June 2025 despite the absence of a pickup in yield.

They explain that “a flat switch for a nine-month extension into the new two-year benchmark is a reasonable tradeoff in our view, given the potential for June 2025 to develop an on-the-run premium as well as having a longer runway to ride on an eventual US monetary policy easing cycle”.

In their report, the team holds a “neutral to negative bias” for the relative performance potential of two-year SGS versus either US Treasuries or Sora OIS.

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“For the two-year SGS – US Treasuries spread, we recognize that the SGS yield discount has historically been deeper for the current level of US Fed funds,” they write. “However, considering that we are already into the tail end of US rate hikes and a similar tapering of the Monetary Authority of Singapore (MAS) tightening impulse, the impetus for repricing the two-year SGS-US Treasuries spread isn’t strong. Instead, we think that the play book for the 2Y SGS-UST spread favours a near term sideways range before a trending move towards diminishing SG yield discount takes hold later in the year.”

The team’s view on the two-year SGS – Sora OIS spread is likely to be centred around zero over the long run and during periods of unchanged monetary policies.

“The OIS curve is a higher beta play (compared to the bond curve) on shifts in monetary policy expectations. Thus, accounting for our ‘topping’ base case for this monetary policy cycle, we see convergence as the path of least resistance for the two-year SGS – Sora OIS spread,” says the team.

“Furthermore, market pricing US monetary policy has already undergone an abrupt shift from too dovish to largely in line with policy makers’ guidance, this will mitigate the scenario where liability hedging flows intensify going forward which would have driven the two-year SGS – Sora OIS spread lower,” they add.

On the whole, the team sees that the upcoming two-year SGS auction has the potential for a “robust outcome” despite an upsize of $0.6 billion compared to the last two-year auction in June 2022.

“June 2025’s yield level is attractive on the assumption that US monetary policy shifts down to a period of pause by the middle of 2023. The probability of a negative surprise for Friday’s auction BTC is low in our view, primarily due to the presence of inelastic demand for the two-year tenor,” says the team.

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