We have established that the Singapore interbank offered rate (Sibor) seems to be highly correlated to the US Federal Reserve funds rate target. Hence, we tend to watch the Fed to find clues to where the mortgage interest rates in Singapore are moving towards.
In August 2015, we forecast that “at a rate of 0.1% drop in unemployment a month, by November, it should fall below 5% at current trajectory and the Fed may be tempted to raise the funds rate target by 0.25% to 0.5% as a precautionary measure”.
In December, US unemployment rate dropped to 5% and the Fed raised the overnight funds rate from 0.25% to 0.5%.
The unemployment rate looks to be on a downward trend, while disposable incomes are rising. Economic and political pressures are building up for wage growth in 2016. Thirteen US states are raising minimum wages.
The Fed would watch keenly whether the economy is overheating and causing inflation and raise interest rate to cool it down.
Labour tightness contributes to inflation, while import price drops are disinflationary. However, personal consumption was at 68.83% of GDP as at November. Hence, rising disposable incomes would likely lead to inflation. Oil price may recover in 2016, raising the inflation figure.
The rest of the world was largely in a deflationary environment. This caused the US import prices to dip, further aided by the strengthening US dollar. The drop in oil import price played a large part in the drop in US import prices, leading to low inflation in the US in 2015.
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Interest rates in major economies
Is the world headed for recession? We can look at the respective regions’ interest rates as an indicator.
Interest rate in the euro area is flat at 0.05% — the lowest ever. China’s one-year benchmark lending rate broke a new low at 4.35% and Japan’s interest rate is 0%. This indicates weakness in the economic outlook for Europe, China and Japan. In the case of the euro area and Japan, the interest rates cannot drop further. Hence, monetary easing is implemented to try to create inflation.
The euro area, China, Japan and the US make up about 65% of the world’s economy at US$18 trillion ($26 trillion), US$10 trillion,US$4.6 trillion and US$17 trillion respectively. The US picks up pace in recovery, while the rest of the world struggles with a slowing economic growth.
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What is Singapore’s nominal effective exchange rate?
Singapore’s nominal effective exchange rate (NEER) is a composite index of a trade-weighted basket of currencies (generally thought of as 15) of Singapore’s top trading partners. Hundred is the average, while above 100 means appreciation against the trade-weighted basket of currencies and below 100 means depreciation against the basket of currencies. The reason for this is to maintain price stability for sustained economic growth.
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What is price stability?
Price stability means minimum volatility and low core inflation — generally in the range of 0% to 3%. This is so that businesses can plan better and use resources more efficiently. Price stability can be attained through:
• Exchange rate
• Monetary base
• Interest rates.
Impact of open economy and price stability
Singapore is an open economy where trade is more than 250% of its GDP.
With such huge imports and exports, this means that domestic policies, monetary supply and interest rates have a lesser impact on inflation than exchange rate. A stronger Singapore dollar will lead to cheaper imports and lower inflation but more costly exports, while a weaker Singapore dollar will lead to higher inflation (owing to higher import prices)but potentially higher exports. However, higher interest rates do not severely impact the manufacturing sector, as Singapore’s manufacturing sector consists of large companies that can self-fund their expansion or transfer funds from their headquarters. Interest rates affect property developers.
As the Monetary Authority of Singapore has observed that the three-month US dollar Sibor and the three-month Singapore dollar Sibor track each other closely, the US and Singapore economies are extensively correlated. Moreover, owing to Singapore’s role as an international financial centre with an open economy, “small changes in the difference between domestic and foreign interest rates can lead to large and quick movements of capital”, according to MAS. A negative capital account indicates capital outflow and is generally undesired, unless the outflow is due to investments overseas.
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MAS monetary policy stance —gradual appreciation of NEER policy band
For Singapore, monetary policy means exchange rate policy. The country’s weak economic growth meant that MAS has to change its policy stance to “gradual appreciation of the NEER policy band. However, the rate of appreciation will be reduced slightly”.
This means that Singapore will continue to maintain a strong currency, but it will reduce the speed of the Singapore dollar becoming stronger.
Because of Singapore’s open economy, a small change in interest rates of the US as well as Singapore’s major trading partners “can lead to large and quick movements of capital”. Hence, Fed interest rates hikes will lead to Singapore interest rates rising in tandem.
While the US is not Singapore’s major trading partner, it is the second-largest economy after the European Union and the US dollar is still the dominant foreign reserve currency. However, Singapore’s use of NEER means that it will weigh its currency appreciation against the trade-weighted basket of currencies. This means a slight depreciation against the US dollar and Hong Kong dollar, and slight appreciation against the currencies of its major trading partners, given their current economic weaknesses.
The International Monetary Fund included the renminbi in its special drawing rights in November (effective Oct 1, 2016), making it one of the five global reserve currencies. It is expected that Singapore will make adjustments to its NEER to account for this major event.
When there is weakness in the economy, a country cannot easily maintain a strong currency stance artificially, unless it has huge reserves to defend its stance, or it will open up arbitrage opportunities to speculators such as George Soros. Therefore, in my opinion, Singapore’s adjustment to its policy stance is right.
What happens during a currency appreciation policy stance?
When a currency adopts a believable currency appreciation policy stance, funds will flow into that currency. During this time, funds will be ample and interest rates will be low (sometimes even negative). Other times, a currency appreciates as a result of other currency’s policy stance.
For instance, the Swiss franc — a safe haven currency — appreciated instantly against the euro in response to the European Central Bank’s printing of money, indicating weakness in the economy.
On the same day, the Swiss National Bank set its interest rate at -0.75%. This is to discourage funds from flowing into the Swiss franc.
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The day SOR went negative
On Aug 17, 2011, the Singapore swap offer rate (SOR) was negative. This was to stop the flood of US dollars coming into the Singapore dollar, owing to the Singapore dollar appreciating against the US dollar. Funds are willing to bear with negative interest rates in view of an appreciating currency.
When a currency depreciates, it is the opposite. Interest rates will have to rise to mitigate funds outflows.
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Summary and mortgage interest rate forecast for 2016, 2017 and 2018
A number of board members of the Federal Open Market Committee forecast median federal funds overnight rate targets in 2016, 2017 and 2018 at about 1.5%, 2.75% and 3.5% respectively, and a longer-run interest rate at 3.25% to 3.5%. If these forecasts were to hold true, they will exert upward pressure on the Singapore dollar Sibor overnight rates.
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A typical US economic recovery runs for several years and Singapore is just entering a weakening economic cycle. Singapore’s largest trading partner, China, enters a slower growth phase, while its second-largest trading partner, Malaysia, is also slowing down.
A slight and gradual appreciation of the NEER policy band means that the Singapore dollar will have to find the trade-weighted “middle ground” as well as a bit on the “appreciation” side. Given that the US is recovering and the rest of the world is slowing down, the Singapore dollar will depreciate against the US dollar and appreciate against many currencies.
Any currency depreciation will need to increase its interest rate to equalise or funds movement will be fast (in an open economy) and free market will equalise the interest rate upwards.
It would be hard to make a guess into the future, but if we are forced to make a guess based on the data we have now, iCompareLoan.com forecasts:2016: one-month Sibor to be in the range of 1.4% to 2%2017: one-month Sibor to be in the range of of 1.9% to 2.5%2018: one-month Sibor to be in the range of of 2.4% to 3%2019: one-month Sibor to be in the range of in the range of 2.4% to 3%.
Paul Ho is chief mortgage consultant of iCompareLoan.com. He can be contacted at paul@icompareloan.com.
This article appeared in The Edge Property Pullout, Issue 710 (January 11, 2016) of The Edge Singapore.