The Feds increased their interest rates…but that’s in the US. What has it got to do with the rest of the world, especially Singapore?
Before we go into the implications, here’s a brief recap on Interest Rates, as the indispensable part of monetary policy:
As Investopedia puts it nicely,
Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).
Thus, an increase in interest rates means a shrinking of money supply. That’s why the USD rallied after the hike.
When USD rallies, SGD as a currency pair weakens.
But other than SGD, how does an increase in US interest rates affect Singapore?
It affects primarily 3 aspects of the economy, other than currency:
Property-linked stocks like REITs
The stock market
Firstly, it affects the interest rates of banks in Singapore. There are two specific rates that mortgage loans can be based on: the Singapore InterBank Offered Rate (SIBOR) and the Swap Offer Rate (SOR).
By definition, SIBOR is the rate at which banks lend to one other in SGD. The SIBOR is also used by banks to set housing loan rates. Banks set the monthly rate using the SIBOR rate on the first business day of the month. It is affected mainly by US Fed interest rates and liquidity in Singapore banking sector.
SOR is the USD version of SIBOR. As a currency-linked rate, it can be more volatile than SIBOR. As such, both SIBOR and SOR are correlated and move in the same direction.
When US interest rates increase, home owners who took up floating-rate mortgage loans pegged to SIBOR or SOR will find themselves paying higher interest. As SIBOR and SOR rates are monthly rates, the rates where home owners pay will fluctuate every month, especially when the US Fed has hinted there will be more interest rates to come in 2017.
As shown above, when the US first increased interest rates back in December 2015, it caused SIBOR to hit an all-time high in 2 years. Chart reference here.
Property-related stocks like REITs
When loan rates increase, it makes it more expensive for the management of real estate investment trusts (REITs) to borrow in order to develop or expand properties. Moreover, interest rates are especially crucial as many REITs have existing debts in the form of loans, which is often indicated by gearing ratios such as debt-to-equity ratio.
Also, as REITs are required by law to distribute 90% taxable income per annum as dividends, the management may be required to increase their revenues from increasing the rentals of existing properties to maintain yield. When rental income is increased, tenant occupancy is likely to be affected.
Hence, when these two possibilities come into place, REITs investors can expect lower dividend yields and prices.
The Stock Market
Since the previous hike in December 2015, the STI fell by more than 12% in the following month. Although the index recovered in the next few months, the direct impact of a US rate hike is undeniably substantial. This is especially important when rates are expected to be more frequent and higher next year.
A rate hike essentially means a shrinking of the money supply to curb inflation. When there’s inflation, there’s growth. US has been growing at a steadily for the past few years, under the Obama administration. However, the incoming Trump administration could shift things entirely (just think Trans-Pacific Partnership). Even in non-economic related news, Trump is known to be aggressive as a politician. This increases geo-political risk which can increase market volatility. So investors, brace yourself and prepare for volatile and gloomy times ahead.
If you’re also wondering which stocks to pick or avoid just like we do, head over to this post to see what the community thinks.