How do interest rate hikes affect your investments?
Most people in Singapore know that interest rates are essentially the cost of borrowing. Anyone with a home loan will be familiar with the rate of interest that he or she is paying, and no one wants to pay interest on his or her credit card because the rate is so high.
However, unless you are an economics major, you are unlikely to know quite as much about how US interest rates directly affect Singapore, and in particular how they may affect your own financial situation.
How interest rates work
The key interest rate for borrowers in Singapore is the Singapore Interbank Offered rate (SIBOR). It is the reference rate, or benchmark rate used by banks in Singapore when they lend unsecured funds to each other, and is also the reference rate used for the majority of mortgage loans in Singapore. Throughout Asia it is similar to the widely used LIBOR (London Interbank Offered Rate) and Euribor (Euro Interbank Offered Rate).
Together with the rate on US government bonds, or treasuries, the most closely watched interest rate benchmark in the world is the U.S Federal fund rates (FFR). Central banks monitor the regular meetings of the Fed to gauge and understand the decisions about the current and future direction of the FFR.
The FFR is a benchmark rate because many countries peg their currency to the US dollar, and when US interest rates rise, this usually means a stronger local currency. Dollar pegging is common around Asia, and is used by the Monetary Authority of Singapore (MAS) for setting currency and interest rates.
This means that when the Fed raises rates, you can be pretty certain that the SIBOR will rise as well, although the magnitude may not be exactly the same.
Since late 2015, the Federal Reserve has been embarking on a rate rise policy. This follows many years of extraordinarily low rates following the Great Financial Crisis of 2008. Given the slower growth patterns being experienced by important trading partners of the US, China in particular, this policy has been extremely measured. Naturally the Fed is also reluctant to force significantly higher borrowing costs onto its own economy, which could choke off the recovery in housing and damage consumer sentiment. Student loans and car loans would also be negatively affected.
So how will your financial situation in Singapore be impacted by a rise in US interest rates?
1.Mortgage rates will move up
Amongst the first to feel the impact of an increase in US interest rates will be those servicing a mortgage loan in Singapore. Higher SIBOR rates due to the pegging would automatically lead to higher monthly repayments on home loans.
Rising interest rates usually act as a brake on the property market because of the increased cost of borrowing (or leverage). Typically, more people will decide to postpone property purchases to avoid rising costs and wait for prices to go lower.
2.Cash-type investments will likely be popular
In a rising rates environment, cash-type investments may enjoy some popularity with investors. Such investments include deposit accounts or money market funds. Since the risk of these types of investments is fairly low, and returns will be improving, it makes sense for investors to park their money in the safety of cash, even if only for a short while.
3.Stock market will struggle to be hugely bullish
Hitherto, stock markets have generally performed better during times of loose or easy monetary policy with low interest rates. A rising rate environment tended to have an adverse impact on the overall stock market. This was clearly evidenced in early 2016 after the Fed tightening, and global sentiment was grim.
But the impact of rising rates on the stock market is not always an immediate fall in share prices. In the past, interest rate rises were usually deemed necessary to curve excess demand, inflation, and bubbles. Therefore, rising rates implied the economy was going to slow sharply, and enter a recession to correct the excesses. More recently, higher rates have come to be regarded by certain participants in the stock markets as a ‘normalization’ process, after 8 years of ‘abnormally’ low levels in the US. In other words – a healthy development.
Banks in particular are forecast to benefit enormously from an improvement in the lending spread. But whether or not a positive interpretation is correct over the longer term, Singaporeans with exposure to the stock market should probably not turn excessively bullish at this stage. In any event, it is rarely advisable for investors to do anything drastic with their portfolio, so at most a re-balance might be considered.