Expectations of a March Federal Reserve rate hike are near 100% as economic data strengthens. Federal Reserve policy rate decision expected on Thursday, 2.00AM, Singapore time.

 Cyclical sectors typically have strongest positive correlations to a rising interest rate environment. Singapore banks have generated an average total return of 17.8% (vs STI’s 12.2%) since 8 Nov-16, on the back of strong institutional investors buying activity.

Defensive sectors such as REITs are also sensitive to interest rates. The S-REIT Sector currently offers a yield spread of c430bps, higher than the long-term average of c340bps, which may imply that investors have largely factored in potential rate hikes this year.

Strong Data Boosts Expectations of March Fed Hike

Investor expectations of a March rate hike by the US Federal Reserve has risen considerably. According to Bloomberg’s World Interest Rate Probability (based on futures trading data), expectations of a rate hike rose significantly from 52% at the end of February to almost a 100% today (see chart).

Rising expectations of a rate hike might be attributed to a comment made in early March, where Fed Chair Janet Yellen stated that “it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect”. Yellen also pointed out that core inflation (excl. volatile food and energy prices) in the US is at 1.7%, vs the Fed’s target of 2%.

US economic data continues to strengthen as February’s nonfarm payroll report (released last Friday) showed the creation of 235,000 new jobs, beating expectations of a 190,000 increase (according to Reuters). Unemployment rate also declined to 4.7% in February, vs 4.8% in January.

The Fed will hold their Federal Open Market Committee (FOMC) meeting on 14-15 March where analysts expect the benchmark fed funds rates to be raised by 25bps to a range of 0.75%-1.0%. Industry analysts expect three rate hikes over the course of this year. Any decision on a rate hike will be released in a statement by the Fed on Thursday, 2.00AM, Singapore time.

Expectations of a rate hike has spiked up since early March

chart 1

Source: Bloomberg World Interest Rate Probability (data as of 13 March 2017)

 Potential Impact of a Rising Interest-Rate Environment

 A rising interest-rate environment typically points to improving economic conditions and may have an impact on different equity sectors in the market.

Banks, Industrials, and other cyclical sectors typically benefit from an interest rate cycle. Specifically for banks, net interest margins (NIMs) typically increase from higher interest rates. Cyclical sectors also typically benefit as an improving global economy will likely result in an increase in capital spending.

Conversely, defensive sectors such as real estate investment trusts (REITs), utilities, and telecommunication services have a history of underperforming. These sectors typically have higher dividend yields and rising interest rates may make these sectors less attractive from an investor’s standpoint. Specifically for REITs, higher interest rates may lead to a rise in financing costs, impacting profitability and the ability to acquire assets.

Banks Saw Strong Returns Since November 2016

 Singapore banks have an average total return of 17.8% since 8 November 2016, outperforming the STI’s 12.2%. The strong returns are backed by a net buy of S$1.43 billion by institutional investors during the same period (according to SGX data). The three Singapore banks are trading at a price-to-book (P/B) ratio of 1.1x with an ROE of 10.0%.

Strong net buying activities in Financials stocks since Nov-16 (S$M)

chart 2

Source: SGX data

Beyond rising interest rates, asset quality remains a focus for Singapore banks in 2017. According to Moody’s Investors Service, Singapore banks saw further decline in profitability and mixed asset quality performance in 2016, but expect pressure on credit costs and net interest margins to subside this year, providing support to profitability.

The table below details the three banks and is sorted by market capitalisation. Click on each stock to visit its profile page on SGX Stock Facts.

Name SGX Code Market Cap S$M Total Return YTD % Total Return 1 Yr % Total Return 3 Yr % P/E P/B Dvd Ind Yld % ROE %
DBS Group Holdings D05 48,133 10.2 30.5 34.0 11.2 1.1 3.1 10.0
Oversea-Chinese Banking Corp O39 40,001 7.7 13.8 18.2 11.6 1.1 3.7 9.9
United Overseas Bank U11 34,997 5.3 19.7 20.8 11.5 1.1 3.2 10.2
Average     7.8 21.3 24.3 11.4 1.1 3.4 10.0

Source: SGX, Bloomberg & SGX StockFacts (data as of 13 March 2017)

S-REIT Sector Yield Spread & Rate Hike Expectations

 Rising interest rates and the steepening of the yield curve typically impact REITs’ distribution per unit (DPUs) due to higher financing costs and may also cap the sector’s price performance.

The Singapore REIT Sector is trading at a forward dividend yield of 6.7% (compared to its five-year historical average of 6.4%) with a price-to-book (P/B) ratio of 1.0x (five-year historical average at 1.0x). When compared to Singapore’s 10-year government bond yield, the sector currently offers a yield spread of c430bps, higher than the longer-term average of c340bps (see chart below). As a reminder, the SGX S-REIT Index has declined 4.8% from the peak in September 2016. This may imply that the investment community has largely factored in the rate hike this year.

SG REIT Sector yield spread at c430bps

chart 3

Source: Bloomberg

According to a report by MAS, S-REITs have also improved their debt profiles – where the weighted-average debt maturity in the sector has increased to 3.5 years, from 3.2 years in 2013. Based on MAS analysis, S-REITs appear well-placed to withstand interest rate hikes as they have used derivatives to convert part of their floating-rate borrowings to fixed rates. Stress tests on S-REITs also showed that their median interest coverage ratio (ICR) remains at a healthy ratio of 4.0 after hedging, even when interest rates rise by 3 percentage points. For more information click here.

S-REITs are relatively less levered, having an average net gearing ratio of 33.3%, which is well below the maximum of 45% as set by the Monetary Authority of Singapore (MAS).

Investors who would like to invest in REITs for sustainable income and long term capital growth can consider the upcoming NikkoAM-StraitsTrading Asia Ex Japan REIT ETF to be listed on 29 March 2017. The REIT ETF provides a broad exposure to diverse properties sectors across the region (estimated 70% exposure to Singapore listed REITs) and has an indicative net dividend yield of more than 5% per annum.  In a recent retail seminar,  NikkoAM provided some key points on the impact of rising interest rates on REITs:

  • While rising interest rates are a headwind for REITs, most REITs in the Asia ex-Japan REIT ETF have a significant portion of their debts pegged to fixed interest rates (at about 70%)
  • Every 100 basis points hike in interest costs is estimated to have a 2% negative impact on annual earnings and dividends. The impact is spread over several years given that a significant portion of the debt is pegged to fixed rates.
  • Net profit and DPU are more sensitive to top-line growth than a rise in interest expense. It is estimated that every 1% rise in revenue can offset a 7.6% rise in interest expenses.

For more information on this new REIT ETF, click here

S-REITs Sorted by Gearing Ratio

The table below details the 38 trusts and is sorted by gearing ratio. Click on each stock to visit its profile page on SGX Stock Facts.

Name SGX Code Market Cap S$M Gearing % Total Return YTD % Total Return 1 Yr % Total Return 3 Yr % P/B Dvd Ind Yld %
Cache Logistics Trust K2LU 725 42.8 2.3 5.5 -7.7 1.0 9.1
Sabana Shari’ah Compliant Industrial REIT M1GU 479 42.8 22.5 -8.9 -34.2 0.6 7.7
IREIT Global UD1U 448 41.4 6.5 15.1 N/A 1.1 8.6
Mapletree Logistics Trust M44U 2,663 39.5 6.8 16.6 28.0 1.0 7.0
Mapletree GCC Trust RW0U 2,712 39.4 2.6 13.4 40.8 0.8 7.4
Ascott Residence Trust A68U 1,802 38.9 4.5 8.2 18.5 0.9 8.1
OUE Hospitality Trust SK7 1,224 37.8 5.1 4.7 8.6 0.9 8.0
OUE Commercial REIT TS0U 886 37.7 1.4 9.4 17.2 0.7 7.1
Frasers Hospitality Trust ACV 1,240 37.5 4.6 -1.2 N/A 0.9 9.0
Cambridge Industrial Trust J91U 744 37.3 7.4 12.8 -1.1 0.9 7.1
Ascendas REIT A17U 7,119 37.1 12.4 11.2 41.7 1.2 6.3
Soilbuild Business Space REIT SV3U 664 37.0 1.7 -4.3 7.7 0.9 9.9
Viva Industrial Trust T8B 752 36.8 4.0 18.1 32.3 1.0 9.0
CDL Hospitality Trusts J85 1,380 36.6 8.7 16.4 6.2 0.9 8.0
Manulife US REIT BTOU 743 36.6 3.1 N/A N/A 1.1 4.2
Suntec REIT T82U 4,427 36.4 8.3 11.7 24.3 0.8 5.9
Parkway Life REIT C2PU 1,458 36.2 4.3 8.6 22.6 1.4 5.0
Frasers Commercial Trust ND8U 1,002 35.9 1.2 7.7 22.7 0.8 8.0
Mapletree Commercial Trust N2IU 4,235 35.1 8.1 11.1 46.5 1.1 5.6
CapitaLand Retail China Trust AU8U 1,241 35.1 7.2 7.5 26.1 0.9 6.7
Starhill Global REIT P40U 1,592 34.8 1.0 3.9 15.5 0.8 6.9
Far East Hospitality Trust Q5T 1,056 33.1 -0.6 -1.0 -11.7 0.6 7.6
Keppel REIT K71U 3,385 32.9 2.0 10.0 7.2 0.7 5.8
Ascendas Hospitality Trust Q1P 843 32.7 6.4 5.2 28.4 0.9 7.1
CapitaLand Commercial Trust C61U 4,540 32.7 7.3 13.0 23.3 0.9 6.1
AIMS AMP Capital Industrial REIT O5RU 849 32.3 3.6 6.8 28.4 0.9 8.3
CapitaLand Mall Trust C38U 6,860 31.8 4.5 -3.0 20.3 1.0 5.9
Lippo Malls Indonesia Retail Trust D5IU 1,094 31.1 7.8 38.0 26.1 1.0 8.9
First REIT AW9U 992 30.8 3.7 12.8 46.1 1.3 6.6
Keppel DC REIT AJBU 1,296 29.7 2.4 19.1 N/A 1.2 4.8
Fortune REIT F25U 2,961 29.3 -0.8 15.3 91.1 0.7 5.8
Frasers Centrepoint Trust J69U 1,807 28.3 5.7 5.3 37.1 1.0 5.8
Mapletree Industrial Trust ME8U 3,010 28.2 3.0 14.4 55.8 1.2 6.8
BHG Retail REIT BMGU 333 28.0 3.8 -11.6 N/A 0.8 3.8
Frasers Logistics & Industrial BUOU 1,351 27.8 3.2 N/A N/A 1.0 1.9
SPH REIT SK6U 2,464 25.5 2.4 6.4 14.8 1.0 5.6
EC World REIT BWCU 580 18.8 0.0 N/A N/A N/A 2.0
Saizen REIT* T8JU 15 0.0 -43.1 -24.6 10.6 1.7 N/A
Average 33.3 3.5 7.8 22.4 1.0 6.7

Source: SGX, Bloomberg & SGX StockFacts (data as of 13 March 2017)

*Saizen REIT announced that it will not proceed with the proposed RTO transaction between the manager and Sime Darby Property Singapore Limited. For more information click here.


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