Step-up In Intensity Of Hawkishness
FOMC minutes and recent comments by Fed officials indicate that interest rate hikes are
likely to be frontloaded in 2022, and quantitative tightening should commence in May 22.
We expect the next two rate hikes to be 50bp each. The resilient labour market will help
the US economy weather the tightened monetary policy and higher interest rates, which
are positive for banks. BUY DBS (Target: S$39.55) and OCBC (Target: S$15.50) for their
2022 dividend yields of 4.1% and 4.6% respectively. Maintain OVERWEIGHT.
WHAT’S NEW
• Fed officials clamouring for 50bp hikes. Many Fed officials have voiced support for 50bp
hikes during upcoming FOMC meetings as well as frontloading interest rate hikes in 2022.
Vice Chair Lael Brainard has recently stressed that the Fed is prepared to take stronger
action in raising interest rates as controlling inflation is of paramount importance. Mary Daly,
President of San Francisco Fed, said that the case for a 50bp hike has grown. James Bullard,
President of St Louis Fed, is the most hawkish and advocates moving the Fed Funds Rate
above 3% by end-22.
• Series of 50bp hikes in the making. Many FOMC participants judged that it is appropriate
to move monetary policy towards a neutral posture expeditiously, which could entail raising
the Fed Funds Rate to about 2.5% by end-22. This implies successive hikes of 50bp during
upcoming FOMC meetings on 3-4 May and 14-15 June.
• The next step is quantitative tightening (QT). The Fed will unveil its plan to reduce the size
of its bloated balance sheet (that currently stands at US$9t) during the next FOMC meeting
on 3-4 May 22. It would allow Treasury securities and agency mortgage-backed securities to
mature and run-off naturally. FOMC participants have agreed to a monthly cap of US$95b,
comprising US$60b for treasury securities and US$35b for mortgage-backed securities. The
pace of QT is much faster compared to the monthly cap of US$50b for the last QT conducted
in 2017-19. QT would drain liquidity from the financial system.
• Mortgage refinancing already hit by tighter monetary policy. The Fed will consider
prioritising downsizing its holding of mortgage-backed securities of US$2.6t at an even faster
pace, which could be achieved by outright sale. In future, the Fed’s balance sheet would
comprise primarily of treasury securities. Thus, interest rates for 30-year fixed mortgages
have hit the highest level in three year at 4.8% recently.
ACTION
• Acclimatising to heightened geopolitical tension. Russia’s invasion of Ukraine has been
bogged down by tactical blunders, inaccurate intelligence, faulty equipment and
overstretched supply lines. The Ukrainians have posed stiff resistance and are continuously
resupplied with ammunition from Western countries. The attack on Kyiv has stalled and the
risk of Ukraine’s capital Kyiv being seized by Russians has abated. Russian forces have
regrouped to concentrate on the breakaway Donbas region. The conflict could degenerate
into a protracted stalemate as Russians deploy siege tactics in the new battleground of
Eastern Ukraine.
• Systemic risk has eased. FRA-OIS spread, a measure of dollar funding stress, hit a peak of
37bp in mid-March but has since subsided to the current 14bp. The level of systemic risk is
modest compared with previous crises, such as Europe’s Sovereign Debt Crisis (peaked at
59bp in Dec 11) and the COVID-19 pandemic (peaked at 79bp in Mar 20). Russia is not well
integrated into the global financial system. Financial linkages with other countries have been
reduced since the European Union first imposed sanctions after Russia annexed Crimea and
Sevastopol in 2014. Russia and Ukraine accounted for just 2% of global GDP in aggregate in 2021. Thus, financial markets are under some stress but remain functional.
• US labour market remains resilient. The US economy added 431,000 jobs in Mar 22 as
hotels, restaurants, retailers and manufacturers hired more workers. The unemployment rate
dropped from 3.8% to 3.6%, which is near pre-pandemic levels and 50-year low of 3.5% in
Feb 20. Increase in average hourly earnings remains robust at 5.5% yoy. Chairman Jerome
Powell commented that the labour market is tight to an unhealthy extent.
• The resilient labour market supports growth in domestic consumption. It will help the
economy to weather the series of interest rate hikes and generate sustained recovery.
• Maintain OVERWEIGHT. Tighter monetary policy and higher interest rates are positive for
banks. The Russia-Ukraine war exacerbates higher inflation, which keeps bond yield higher
for longer. BUY DBS (Target: S$39.55) and OCBC (Target: S$15.50) for their 2022 dividend
yields of 4.1% and 4.6% respectively.
DBS (DBS SP/BUY/S$35.33/Target: S$39.55)
• We expect NIM to expand by 4bp to 1.49% in 2022 and 25bp to 1.73% in 2023. We forecast
earnings growth of 9.6% in 2023 and 10.8% in 2024.
• We expect DPS of S$1.44 in 2022 and S$1.48 in 2023, which represents dividend payout
ratios of 53.7% and 50.3% respectively. DBS provides dividend yield of 4.1% for 2022 and
4.2% for 2023.
• Our target price of S$39.55 is based on 1.64x 2023F P/B, derived from Gordon Growth
model (ROE: 12.6%, COE: 8.25% (previous: 8.5%), growth: 1.5%).
OCBC (OCBC SP/BUY/S$12.26/Target: S$15.50)
• We expect NIM to be unchanged at 1.55% in 2022 and expand 15bp to 1.70% in 2023. We
forecast earnings growth of 11.7% in 2023 and 6.9% in 2024.
• We expect DPS of S$0.56 in 2022 and S$0.60 in 2023, which represents dividend payout
ratio of 50.3% and 48.2% respectively. OCBC provides dividend yield of 4.6% for 2022 and
4.9% for 2023.
• Our target price of S$15.50 is based on 1.22x 2023F P/B, derived from the Gordon growth
model (ROE: 10.0%, COE: 8.25% (previous: 8.5%), growth: 0.5%).
SECTOR CATALYSTS
• Economic recovery driven by reopening and easing of COVID-19 restrictions.
• Banks pay more dividends as risks emanating from COVID-19 pandemic recede.
ASSUMPTION CHANGES
• As per mentioned above.
RISKS
• Escalation of the Russia-Ukraine war beyond Ukraine.
• Geopolitical tension and trade conflict between the US, China and Russia.