When the US Federal Reserve cuts rates, what does that mean to you?
The US Federal Reserve cut rates by 0.25% points in July, for the first time in 11 years. The question on many Singaporeans’ mind is, what does it mean and how does it affect the interest rates we pay on our home loan?
First of all, what the US Federal Reserve controls is the federal funds rate, the cost of uncollateralised overnight borrowings between financial institutions and banks in the US. A rate hike or a rate cut refers to an increase or decrease of the current federal funds rate.
In this latest adjustment, the federal funds rate was cut by 25 basis points, or 0.25% points, to 2.25%. Fed Chair Jerome Powell stated that the rate cut was to “insure against downside risks from weak global growth and trade policy uncertainty, to help offset the effects these factors are currently having on the economy”.
Indeed, some market watchers did not feel this move by the Federal Reserve was justified, given that the economy was healthy, and both unemployment rates and inflation rates were at historical lows.
How does the Fed rate cut affect the US?
The effects of that rate adjustment does not have a direct nor immediate impact on interest rates that consumers encounter, but it does trickle down to consumers indirectly because it is one of the ways the Federal Reserve uses monetary policy to ward off a possible recession, ensure maximum employment, and maintain stable prices.
So within the US, the rate cut minimises the possibility of a recession that would result in layoffs, so more U.S. citizens will remain employed.
Yields on savings accounts follow a similar albeit weaker pattern as the changes in the federal funds rates, while home loan rates – which are longer term by nature – would have already been adjusted ahead of time, in anticipation of future rate cuts or hikes.
What about Singapore then?
In Singapore, the correlation between the Federal Reserve’s rate cut and interests rates here is even more tenuous. That does not mean it has no influence on what happens in Singapore either.
Central banks around the world often take their cue from each other, particularly from the likes of the Federal Reserve and the European Central Bank (ECB). The changes in interest rates around the world impacts the global money market, in turn affecting the Singapore Interbank Offered Rate (SIBOR).
In this case, SIBOR–pegged floating rate home loans would be influenced by the Fed’s actions to some degree.
However, SIBOR is also influenced by other factors, including any adjustments made by the Monetary Authority of Singapore (MAS) to the Singapore dollar Nominal Effective Exchange Rate (S$NEER) policy band.
S$NEER is the exchange rate of the Singapore dollar against an undisclosed basket of currencies of Singapore’s major trading partners, and the MAS manages this exchange rate by adjusting the slope and the width of the policy band in which the exchange rate is allowed to fluctuate.
Earlier in April, MAS maintained the existing rate of appreciation of the S$NEER policy band, owing to the easing of Singapore’s economic growth, and mild inflation rates.
Would we see lower interest rates for our home loans?
This may be possible assuming the Fed were to continue to cut rates in the next few quarters, leading to a longer term trend.
However, the minutes released from the July FOMC meeting on Aug 22 stated that the rate cut was more of a “recalibration” and that the participants “generally favored an approach in which policy would be guided by incoming information and its implications for the economic outlook and that avoided any appearance of following a pre-set course”.
That means future rate cuts may or may not be in the works just yet.
Plus, when prevailing interest rates fall, banks are less likely to lower the interest rates on their loans as quickly as they would raise them when prevailing interest rates go up, given the negative impact the former would have on their net interest margins.
That means Singapore property owners looking to refinance their loans will just have to wait and see.