Weak currency undermines Singapore's safe-haven bonds

By Jongwoo Cheon

SINGAPORE (Reuters) - Singapore is one of the world's few sovereign states with a triple-A credit rating on its debt, but its sliding currency is causing the country's government bonds to behave more like those from riskier emerging markets.

The Singapore dollar has fallen 7 percent against its U.S. counterpart this year, depressed by a year-long monetary easing policy that has hurt demand for government bonds. Investors are also shying away from Singapore assets as they seek higher returns in the United States in the run-up to an expected rise in Federal Reserve interest rates.

While Singapore is Asia's only country with a Triple-A or top rating from all the three major ratings agencies, and is in the same league as Australia, Norway, Switzerland, Germany and Canada, local bond yields have spiked.

Over the past year, Singapore bonds have traded at yields much higher than the world's most liquid safe haven - U.S. Treasury securities - while other top-rated markets have seen their yields decline relative to Treasuries.

"A depreciating currency and general emerging market fear could possibly deter investors from dealing with Singapore bonds," said Gordon Ip, a senior fund manager at Value Partners in Hong Kong, referring to persistent worries about emerging market growth.

Singapore government bonds have not seen as much demand as most other safe-haven bonds, with the yield spread between 10-year Singapore bonds and Treasuries reaching 73 basis points in September. That was the widest since data was available going back to October 1998.

The benchmark 10-year Singapore bond yield is now trading around 30 bps above 10-year U.S. Treasuries, compared with 4 bps below Treasuries about a year earlier. In contrast, yields on German 10-year bunds trade 170 bps below Treasuries now, and Canadian bonds trade 60 bps below Treasuries.

"The underperformance of Singapore bonds is a result of expectations of a stronger U.S. dollar and somewhat heightened sensitivity of local interest rates to U.S. rates," said Mirza Baig, head of currency and rates strategy at BNP Paribas in Singapore, adding that the market had been more volatile than expected given its top credit rating.

POLICY EASING, EMERGING MARKETS

The Monetary Authority of Singapore eased monetary policy via the Singapore dollar exchange rate mechanism twice this year to support the export-dependent economy against the backdrop of a slowdown in global trade and heavy deflationary pressures.

The Singapore dollar is Asia's fourth-worst performer so far this year.

Policy easing - via the Singapore dollar's nominal effective exchange rate (NEER) against that of its main trading partners - has the side-effect of pushing up money market rates and yields.

The three-month Singapore money market rate is now at 1.07 percent and has climbed 62 basis points this year. Ten-year yields have risen 82 bps from their lows in January to 2.63 percent.

Competitive bidding for new debt at government bonds auctions - which usually comes from large institutional buyers and sets the market price - has dropped sharply in recent months.

At the past month's tenders for three- and six-month bonds, competitive bidders took up only 12 to 42 percent of the amount allotted in the auction. Back in 2014, that allotment was as high as 80-90 percent.

Still, institutional demand for Singapore's bonds hasn't dried up and has kept yields from surging as much as other swaps and money market rates. The spread between the 10-year Singapore dollar interest rate swap and the bond yield has widened to 38 basis points from being near flat early this year.

Hee Eun Lee, Asia rates strategist at Standard Chartered Bank in Singapore, expects spreads between U.S. Treasuries and Singapore bonds will normalise next year.

"The yields are undervalued and attractive," Lee said.

"Once the uncertainty over the Fed's rate hike is cleared, Singapore bonds will normalise. Spread between 10-year UST and SGS will tighten."

(Editing by Vidya Ranganathan and Jacqueline Wong)