GBP is not a one-way bet up; SGSs as low beta USTs


GBP strength will not be a one-way bet. Selected tenors of SGSs look relatively attractive.
Philip Wee, Eugene Leow05 Dec 2019
    Photo credit: AFP Photo


    FX: GBP is not a one-way bet up

    Election fever has gripped the British pound which closed above 1.30 for the first time since May. Sterling has been rallying after YouGov predicted in late November a 68-seat majority for Prime Minister Boris Johnson and his Conservative Party at next week’s general election on December 12. YouGov correctly foretold that former Prime Minister Theresa May would lose the majority at the previous snap election in June 2017.


     
    Despite the optimism, GBPUSD still needs to first overcome the year’s high around 1.3340. The election is potentially a “buy the rumour, sell the fact” event risk. A Tory majority would not be able to paper over the hard trade negotiations ahead with the EU, the still-weak UK economy, the Bank of England’s rate cut bias and the risk of fiscal slippages hurting the country’s sovereign debt rating.

    Unfortunately, no one is truly ready to write off the prospect of a hung parliament a week from now. The debate between Mr Johnson and opposition Labour leader Jeremy Corbyn (held after the YouGov poll) was considered a tie. Like the Tories, support for Labour has also increased at the expense of the Liberal Democrats and the Brexit Party. YouGov would not discount a hung parliament if the Conservative-Labour lead narrows to 7 points. This outcome would pummel GBPUSD below 1.30 to 1.25 again. The return of political paralysis could renew prospect of a no-deal Brexit on January 31, 2020, and pressure GBPUSD towards 1.20 again.

    Rates: SGSs as low beta USTs               
            
    We think that SGSs will continue to hold up relatively well through the ongoing bout of volatility and see pockets of value emerging in the belly tenors. SGSs have been relatively stable compared to US Treasuries. Over the past three months, 5Y SGS yields have hovered within a 12bps range (1.58-1.70%) compared to the 40bps range (1.35-1.75%) for 5Y Treasuries. Given that the SGD has strengthened versus the USD over the period, the risk-adjusted return for SGSs is compelling. In periods of risk aversion, underperformance in SGSs versus USTs is inevitable. However, lower beta in SGSs could be attractive to investors.
     
    We think that 2Y and 5Y SGSs are relatively attractive.  While USTs have rallied on China-US trade war risks over the past two trading days, yield declines in SGSs have been more muted. We suspect that profit taking amongst the local players as year-end approaches may be the key factor limiting a bigger rally in SGSs. SGS-swap spreads also look stretched in the 2Y and 5Y tenors, at 9bps and 13bps respectively. From an asset-swap perspective, these tenors should still be enticing to USD-based investors.



    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

     

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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