[KeyTakeaways] Live:Navigating the Market with the Hawkish Fed Act

Speaker:  Bruce Zhang CFA, CSOP Portfolio Manager, PM of the largest China government bond ETF in the World

The recovery in Singapore is well under its way. GDP and export growth is already comparable to pre-covid level. Retail sales are even stronger thanks to the country’s reopening progress and unemployment rate is on a downward trend. However, the high inflation and potential growth headwinds on the back of tightening cycle have great implications on market.

Investors may want to keep their money as SGD cash, which makes sense. But if investors have global allocation and treat USD as their performance currency, then even SGD cash alone may not be perfect as it was down by more than 6% YTD against the greenback. 

There are 3 major risks in global economy - elevated inflation, tightening and recession risk. The inflation risk seems to be quite broad-based in major economies. Then it is not surprising that most central banks need monetary tightening to tame inflation and the US Fed is ahead of its peers. The direct impact of tightening is that demand will be compressed. Even there is no signal of immediate recession, equity and bond investors have been trading such expectations as reflected in a flat or even inverted yield curve and there are also downward revisions to earnings forecasts in the 2nd half this year.

Despite looming outlook, the US dollar strength is likely to continue with rising policy rates. In addition to accelerated rate hike pace, USD is treated as risk heaven and the US relative strong recovery also supports its currency. Driven by these factors, the dollar index has hit a new high since 2003 in June this year and continue to rise thereafter.

The Fed has accumulatively hiked 300bps YTD, leaving the Fed fund rate range at 3% to 3.25% for now. As mentioned earlier, the inflation is the main reason of a hawkish Fed which signed even more aggressive hikes ahead. The Fed officials now forecast that rate would reach 4.4% by end of this year and 4.6% next year, implying a 4th straight 75bps hike is likely in November. Echoing my previous session, the aggressive hike would dampen growth outlook in the following two years.

USD MMF is a relatively safe asset with underlying’s minimum credit quality specified by regulators. It also has relatively low management fee and subscription/redemption fees are typically waived. Its diversification exposure can minimize concentration risk, say if placing money into one bank and its return is competitive (some USD MMF can persistently provide net yield more than 2.5% now) and certain USD MMF can offer T+0 settlement with Moomoo Financial now. All of these provide a good choice for cash management amid a rising rate environment.   

- First are dollar assets, such as USD MMF aforementioned or high-quality IG USD credit with limited duration risk. Investors can lock their yield if holding them to maturity. HY is not a forbidden area, but investors should focus on more liquid names with lower default risk.

- Second are some LC EMD with independent monetary policy vs. the Fed, such as onshore China government bonds.

- The third is REITs (sth between FI and equities), particularly large-cap and liquid S-REITs.

The MMF hedging vs. equity is quite straightforward such as low correlation, downside protection and more flexibility. Within fixed income area, I believe USD MMF can hedge 3 major risks of bonds - namely default risk, FX risk and duration risk particularly on the back of rising rate environment.

The fast pace of hike may at least till end of this year and a relatively gradual hike may last throughout 2023. The Fed may finally stop the hike by the end of 2023 or in 2024, which is also in line with the timing that market expects the inflation to finally return to around 2% level.

I think it's not a black and white argument, because it really depends on client's needs. For example, if some investors they have some spare cash and they don't need it immediately, they may place their money into a fixed deposit. But place all money in one bank may subject to some concentration risk. And comparatively, a money market fund typically place their investment into a diversified exposure. Another important factor is that when investors place their money into a fixed deposit, it means they may not be able to capture the future higher interest rate in the short term.

The money market fund yield advantage may last for a longer time, because within the money market fund strategy, the investment has already locked some yield at peak times. And even in the environment with the relative lower interest rates, we still believe money market fund can be a good supplement to investors because it has a very high liquidity and flexibility to facilitate investors to switch their money in and out from their cash tools. And as compared to a demand deposit, the beauty behind the money market fund is that they can provide a yield comparable to the fixed deposit, but their flexibility is still comparable to the demand deposit.

The money market fund has a relatively high liquidity, doesn't mean that they have no liquidity risk. Another potential risk is the underlying credit risk, so investors should keep an eye on the underlying credit quality allocation. But the good news is that most of the regulators in Singapore already specify a minimum and investment rating to limit the potential downside for the money market funds, which will help to protect investors when investing such a money market fund.

It's really depends, actually. But I have to say the inflation in Singapore is not as high as in the us and the growth-up strength is also not as strong as in the United States. I think that's something that investors should take a consideration.

That's a very big question because there are a lot of funds in the world, but maybe there are still some common rules to measure the risk of different MMFs. The first risk is the liquidity risk, and investors can have a check on their liquidity allocation. Second one is about their credit ratings. And this is also important. Even the regulators may set some minimum rating requirements, different regulators may have different risk appetites.

Money market funds to me, it's an actively managed strategy as compared to index fund. Because in most cases, for equity index fund, it typically tracks the benchmark, which means this is mainly through a passive management. But for money market fund, since they have a very short maturity allocation, which means portfolio manager needs to take care of the money market fund management almost on every day, which means we need to care about the potential interest rate environment, also the potential investable universe to make sure we can always act the best interest to your investors to balance the liquidity and potential yield.

Conclusion: I just want to reiterate that safety, liquidity and yield make the case for USD money market fund, particularly under rising rate environment. Even the Fed will finally turn after 1 or 2 years, MMF can still act as a flexible cash management tool with potential better yield vs. demand deposit.

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