Ripples from Fed's hint on rate hike

NEXT FEW MONTHS? Dr Yellen believes the US should raise interest rates by this year if the US economy continues to improve.


    May 25, 2015

    Ripples from Fed's hint on rate hike

    AFTER a moribund week that saw market sentiments again dominated by economic data and interest rate outlook, uncertainties continue to loom as the United States Federal Reserve is still eyeing a rate hike within this year.

    The latest Fed meeting minutes released earlier last week may have ruled out next month as a starting point to push up the near-zero interest rate in the US, but central bank chair Janet Yellen thinks that it can happen within the next few months.

    "If the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target," she said in a speech on Friday.

    The hint, while unsurprising - 50 out of 62 economists polled by Reuters believe a rate hike is imminent this year - was not welcomed by Wall Street, with the Dow Jones Industrial Average ending 0.29 per cent lower on Friday. For the week it dropped 0.2 per cent.

    At home, the benchmark Straits Times Index (STI) also stumbled through a choppy week when it lost 12.92 points or 0.37 per cent, with volume staying below $1 billion in four out of five sessions.

    The US interest rate is a key figure to watch for markets worldwide as higher rates mean stronger bond yields, which typically pull money away from equities. For Singapore households and corporations, US rate movements also matter as they are also strongly correlated to Sibor (Singapore Interbank Offered Rate).

    Against this backdrop, companies with high net gearing - a measure of a company's borrowings against its own equity - such as oil and gas play Ezion Holdings may suffer.

    DBS Group Research said last week: "Ezion's net gearing stands at over 100 per cent, with 60 per cent of its debt on floating rates. We estimate that every 100 basis-point increase in interest rates could reduce Ezion's net profit by around 1.8 per cent."

    Ezion shares have dropped 10 per cent since the start of this month to close at $1.085 on Friday. Oil and gas plays including Keppel Corp and Sembcorp Marine have yet to see a firm recovery as investors remain unconvinced about the strength of oil price recovery.

    Meanwhile, there is at least one bright spot in a rising interest rate environment, Nomura Securities said in a recent note as it examined the local banking plays - DBS Group Holdings, United Overseas Bank and OCBC Bank.

    "Our economists are not only expecting the current local rates to sustain, but also see another 100 basis points increase next year… We estimate for every 100 basis points increase in interest rates, the return on equity of these banks could rise by an average of 140 basis points."

    Nomura added that valuations of all three local banks remain attractive despite strong gains in the fourth quarter of last year. It named DBS as the sector's top pick.

    DBS shares dropped 1.05 per cent last week to $20.83. UOB lost 0.54 per cent over the past week to close at $24.07, while OCBC ended 1.14 per cent lower at $10.37.

    In the week ahead, Singapore will also release key economic data of its own, with both industrial production and the final first-quarter economic growth rate slated for announcement tomorrow.

    First-quarter growth may be slightly stronger than expected, with economists polled by Reuters predicting a 2.2 per cent year-on-year expansion - a tad higher than the official advance estimate of 2.1 per cent.