Where will Singapore Interest Rates go?
Inspired by an interview question, I decided to take a closer look at where Singapore interest rates would go. More specifically, should you take a fixed-rate loan or a floating one?
Much has been said about the US rate cut cycle, but much less has been said about its impact on Singapore’s interest rates. The US rate uncertainty has imbued some volatility into the markets but more important for the everyman, it has made loan decision-making much more difficult. Looking at the perspective of a prospective home buyer, should you take a fixed-rate loan or a free-floating loan? While we can’t say for sure, but our research suggests that a floating-rate loan might be slightly more beneficial than a fixed rate in the near term.
This piece will focus on three main factors. Firstly, we will explore the historical passthrough of US rates on rates in Singapore. Next, we will look at future MAS policy direction and possible actions. Lastly, we will briefly untangle the US inflation-growth dilemma and what it means for Singapore.
Historical passthrough of US interest rates in Singapore
US rates have been a strong driver in influencing local rates as no-arbitrage conditions force rates to move in tandem with global developments. However, this pass-through is not 100%, Singapore rates have been observed to be more stable than US rates in both a rising and falling rate environment.
Source: Bloomberg, TAM
From Jan 22 to Sep 23, we observed a sustained rise in US 10y Treasury yields which signals a rising rate environment. In this period, we saw that US-SG Overnight Interest Rate Swaps (OIS) spread for both 1y and 5y rose steeply. A one-to-one transmission would show no change in US-SG OIS spreads. Instead, what we see is that US rates rose much faster than Singapore rates, indicating that Singapore interest rates tend to be more stable and are less sensitive to fluctuations in market expectations of future yields. More specifically, it could be estimated that the passthrough of US rates onto Singapore rates stands at approximately 60%, which means that for every 1% rise in USD OIS, SGD OIS only edges up by 0.6%.
Source: Bloomberg, TAM
The Singapore interest rate stability is also seen through a falling rate environment. From Oct 23 to Dec 23, due to some temporary shifts in market sentiment, the 10y US Treasury yield experienced some decline. In this environment, the US-SG OIS spread for both 1y and 5y tenors behaved predictably. We see both OIS spreads fall in line with falling yields, suggesting that US rates in this period fell faster than Singapore rates.
This stability has a few reasons, the first of which is how Singapore issue its bonds. As Singapore does not rely on bonds to fund fiscal spending, Singapore's bond supply is often limited. The second reason is that the MAS implements its monetary policy through currency intervention. As MAS steepens its policy band to tighten monetary policy, this pushes short-term local interest rates down through uncovered interest rate parity. This contradicts US attempts to tighten through hiking policy rates which raise short-term interest rates. The third reason is the fiscal discipline of the Singapore government to keep a balanced budget. As this persistent fiscal prudence is recognised by the market, Singapore bonds are seen as a safe haven asset with little chance of default. This increases the demand for Singapore bonds which stabilizes local yields.
In short, what we observe from US-SG OIS spreads is that Singaporean interest rates tend to remain stable. While it is heavily influenced by movements in the US, it often lags and remains somewhat insensitive to short-term fluctuations. Signs suggest that the US-SG OIS spread will remain positive in the near future as the US rates continue to underperform Singapore rates should MAS maintain its policy stance.
MAS Policy Stance
Singapore’s disinflation journey has been uncertain as data in 2H23 was highly volatile as observers feared some reacceleration in price growth. Fortunately, such fears were slightly quelled in 1H24 as the disinflation journey continued.
Source: Singstat, TAM
Inflation has slowed to 2.7% y/y with core inflation experiencing similar disinflation as it falls to 3.1% y/y from its peak of 5.5%. However, progress has stalled as inflation figures stagnated at 2.7% for 2 months. We see 4 main factors driving this stickiness in inflation; GST hike, Energy, Food and Housing. Each factor has pushed prices up but it should be expected that the worst of these pressures are over.
GST Hike
In anticipation of elderly care-derived budget expansion, the Singaporean government opted to hike its sales tax by 2%. This Good and Service Tax (GST) hike came in 2 parts, the first in Jan 23 and the second in Jan 24. This hike has pushed inflation up in the near term.
Source: CEIC, TAM
While it is difficult to assess the impacts of the GST hikes on inflation, past experiences may shed some light on potential inflation ramifications. The last consecutive 1% GST hikes were implemented in 2003 and 2004 where it rose from 3% to 5%.
In the 12 months following a 1% hike in GST, inflation rose in the first quarter of the year before stabilizing in the rest of the year. It should be noted that while inflation dissipated, linear and persistent disinflation was not observed in 2003 and 2004. Instead, should previous experiences ring true, we should expect the inflationary effect of a GST hike to be alleviated in a slow and rocky way. For the rest of 2024, observers should expect GST-derived inflation to be a persistent factor to consider which would keep consumer goods inflation to be sticky.
Food Inflation
As food in Singapore is mostly imported, global food prices and energy costs are expected to be major drivers of inflation.
Source: UN FAO, TAM
Across the board, food prices have already ticked down since the pandemic but it has not returned to pre-pandemic levels. The easing of supply chain disruptions has brought about significant relief in food prices with cereals leading this trend. However, the slow return to price normalcy has been a source of inflation stickiness. The pandemic has disrupted harvesting and planting cycles which has yet to be fully ironed out, but as we move into the future, this too should subside.
Russo-Ukraine War is a major source of uncertainty in food prices. Russia and Ukraine represent a significant source of grain and agricultural products, so the recent conflict has harmed production cycles and injected volatility into the food supply. The UN FAO Food price index peaked in Feb 22, the month when Russia invaded Ukraine. A significant escalation in the conflict will surely reverse the recent price normalisation trend, but it is unlikely to occur. Both Russia and Ukraine are experiencing concerning logistical bottlenecks that prevent large sweeping offensive actions which will reduce the chances for desperate actions from either side. Russia's battlefield concerns have been well-documented, and the army is reeling from logistical and morale issues. Despite instilling a full-blown war economy, poor transportation systems and warehousing issues have prevented proper sustainment. On the other hand, Ukraine has been reeling from a manpower issue. With battalions in the frontline being decimated to just a fraction of its full operating figure, Ukraine simply does not have enough men to mount a proper assault. Even if we assume that the West regain its political will to support Ukraine, a lack of personnel would ensure that Ukraine will only hold on and not make any gains.
With neither side being able to land a knockout blow, the danger of further escalation remains just a possible concern and not an expected reality. For Singapore, this means that while food inflation may be sticky, a reacceleration in food inflation is unlikely.
Energy Inflation
Global natural gas spot prices have been ticking up in recent weeks but have stayed within pre-pandemic levels. With Singapore’s energy mix being 94% natural gas, the global price movements will be of exceptional relevance.
Source: EIA, TAM
Natural Gas hit historic lows in 1Q24 as milder temperatures and better-than-expected production figures pushed prices down. Year-on-year fall in natural gas consumption has also pushed demand down as renewables establish themselves in the US energy market. The seasonal dip in energy demand in May has also helped to keep prices low.
Towards the end of the month, we note that prices have begun to recover. As producers face lower prices, they decide to scale back production as a profit-maximising strategy. That said, the spread between natural gas prices and hydrocarbon gas liquids (HGL) may support supply. As producers seek to extract HGLs from natural gas production, natural gas output has the potential to remain sticky, preventing continued falls in production figures.
Lower production figures have led to some recovery in spot prices, but it should be noted that this recovery is still within pre-pandemic levels. With supply falling marginally while cooler temperatures suggest softer demand in the coming weeks, it is likely that spot natural gas prices will remain rangebound in the foreseeable future. Should the US continue to expand renewable energy sources, further depression of prices is expected.
These trends point towards continued disinflation in Singapore’s energy inflation basket. Lower spot prices should help ease Uniform Singapore Energy Price (USEP) pressures. Although such benefits may take time to translate into energy price savings by consumers and businesses due to the fuel cost calculation methodology used. Regardless, energy inflation will likely continue to ease in Singapore for the rest of the year with some seasonal peaks in the middle and the end of the year.
Housing Inflation
Shelter in the CPI consists of rent and Owner-Occupied Accommodation (OOA), both heavily rely on prevailing spot rents to guide inflation figures. Imputed rentals, which are proxied by market rents, produce the OOA CPI contribution figures. This informs observers of the hypothetical “costs” that homeowners face in utilizing housing as a service from their own homes.
Source: Singapore Real Estate Exchange, TAM
SRX rental price index is used as a proxy for spot rents in Singapore. Most recent data suggest that the rental price run-up seen in the post-pandemic environment has slowed. Although HDB rental prices are still ticking up, this is likely due to regulatory measures that lead to a slow adjustment of HDB rental prices. The less-regulated non-landed private housing rents show that the market has normalized and has plateaued. A similar trend is expected in the HDB rental market in the following months as supply-demand dynamics normalize.
Source: HDB, MND, TAM
Although rental prices have the most direct influence on CPI data, housing prices have an indirect relationship with CPI data as rental prices are often contingent on the resale value of the unit. In this department, resale prices could experience some strong upward pressure from a weak pipe of HDB units completing its minimum occupancy period (MOP). The MOP is a measure that mandates that homeowners must live in their newly built HDB for at least 5-10 years. This means that in 2024 and 2025, a maximum of 20,000 of new HDB units will enter the resale market. This will be significantly less than the number of units completed in 2022,2023 and 2024. Poor resale supply will likely push resale prices up in the short term. Higher resale prices may manifest in higher rental prices, but this increase in rental prices is expected to be limited due to a relatively competitive rental market.
The implementation of the U-Save will likely lead to some seasonal acceleration in disinflation on a m/m basis. However, the overall impact will likely be minuscule.
As housing inflation data often lags spot rental figures, housing inflation will likely remain sticky in 2Q24 but the worst is over. Housing inflation data will exhibit a downside bias for the rest of 2024 should the trend of spot rent stagnation continue. However, it should be noted that unchecked and continual rises in resale prices could derail these expectations.
MAS policy forecasts
Source: MAS, TAM
Inflation dynamics in Singapore suggest that the worst is over and disinflation is expected to continue in 2024. While it may not be a linear downward path as inflation might be sticky in the short-term, the secular trend is likely biased towards returning to inflation normalcy. Telok Ayer Macroeconomics expects MAS to ease in 1Q25 where data would be more supportive of the narrative that inflation pressures have subsided. This means that the S$NEER bands would be slightly flattened, putting a cap on further SGD appreciation.
The flattening of the S$NEER has an interesting impact on rates in Singapore. As per Uncovered Interest Rate Parity, as the SGD depreciates, we expect short-term rates in Singapore to experience upward pressure. Ironically easing by the MAS raises short-term rates. The intuition is simple, as the SGD depreciates, the return on local bonds and interbank lending falls, reducing its appeal to foreign investors. Investment-Saving market dynamics then pressure short-term interest rates and interbank lending to raise rates to attract hot money once again. Overall, SG rates should follow the US but eventual easing will ensure that the magnitude of adjustment will lag the US, reinforcing SG rate stability. Should the US cut slowly, as we expect, SG rates should slowly follow suit and adjust accordingly.
Source: Bloomberg, TAM
The forward markets seem more hawkish than Telok Ayer Macroeconomics as they see SGD's strength to continue in 2H24. Regardless. future weakness in the SGD would likely result in US-SG OIS differentials narrowing, as the 3m SORA rate experiences some upside bias. If all else holds constant, a 1Q25 easing would result in stronger pass-through rates in Singapore. However, these improved pass-through rates will not cause a significant rate convergence between US and Singapore, allowing Singaporean interest rates to continue to remain stable amidst both rising and falling US rates environment.
To summarize our discussion of Singaporean rates, Singaporean interest rates are strongly influenced by global pressures, mainly by the US. However, US to Singapore rates pass-through is not 100% as Singapore rates tend to remain more stable. As inflation is expected to continue to moderate, MAS will likely ease policy in 1Q25, resulting in a narrowing US-SG OIS spread which suggests that pass-throughs will be stronger in 2025. The improved pass-through will not remove or reverse Singapore’s rate stability but rather slightly negate it. Domestic factors will influence the magnitude of interest rate movements, while US policy rate movements will influence the direction and timing of it.
US Rate Cuts
The US Fed is facing a slowly unfolding dilemma. Inflation-growth dynamics have begun to balance out and the US Fed will face a tough choice between the two. This dilemma is reflected by uncertain forecasts made by major banks and brokers.
In general, we see that most brokers expect September to be the date of the first cut, however, the number of cuts is up in the air. The variety of views shows the level of uncertainty in the market. In fact, I believe that the US Fed governors are unsure of the time and depth of rate cuts too. The June Summary of Economic Projections showed that the median number of cuts expected is just 1 in 2024, but the individual respondents were somewhat evenly split on the specific number of cuts.
Telok Ayer Macroeconomics’s base case is a 25bps cut in Dec 24, but there is a possibility that 2024 will end without a cut if PCE figures remain too strong. While inflation-growth dynamics have balanced out, the US Fed will likely prioritize the end of this inflationary cycle. Powell has said that the risk of higher for longer inflation outweighs an economic downturn. Additionally, the labour market has been somewhat stable, even though unemployment ticked up to 4.0%, it is still historically low while Non-Farm Payrolls continue to beat expectations.
Conclusion
Singapore rates have historically been more stable and lag US rates. Since the US rate cut cycle will start slowly with shallow cuts, Singapore rates should hover at current levels in 2024 with some gentle decline in 1H25 as the US begin to cut. For home buyers, this means that in the coming months, the interest on their mortgage should not vary too much. However, since Singapore rates are expected to decline over time, a floating regime might be slightly beneficial from 2025 onwards, but marginally so.