You will be able to explain how a change in the US federal funds rate tends to show up in Singapore interest rates.
Marcus and Grace bought a resale flat three years ago with a bank loan on a floating rate. They have never once read a statement from the Monetary Authority of Singapore about interest rates, because, as you saw in lesson 1.1, MAS does not set one. Yet every few months a letter arrives from their bank with a new instalment figure, and the size of the change tracks something decided by a committee in Washington. Marcus finds this faintly absurd. Why should the US central bank decide what a couple in Sengkang pays on their flat?
This lesson answers that question. It is the first link in a chain that module 2 follows all the way to your mortgage, your deposits and your T-bills.
The US Federal Reserve, usually called the Fed, sets a target range for the federal funds rate: the rate at which US banks lend to each other overnight. Its rate-setting committee meets on a published schedule, and after each meeting it announces whether the range goes up, goes down or stays put.
That overnight rate is the floor under almost every other US dollar interest rate. US Treasury bills, bank deposits and corporate loans are all priced with it in mind. And because the US dollar is the currency most of the world borrows, saves and trades in, that floor reaches well beyond the US. A bank in Singapore that lends in US dollars, a fund that holds US Treasuries, a company in Indonesia with a US dollar loan: all of them feel a change in the Fed's range.
Now bring in the two facts from lesson 1.1. Money moves freely in and out of Singapore, and MAS manages the exchange rate instead of an interest rate.
Picture an investor with money to park for three months. She can hold US dollars and earn the US rate, or convert to Singapore dollars and earn the Singapore rate. If Singapore rates sat far below US rates for no good reason, money would flow out of Singapore dollars into US dollars to earn more. If they sat far above, money would flood in. Either flow would push the exchange rate around, and MAS would have to step into the currency market to keep the S$NEER inside its band.
Because MAS keeps the exchange rate on its chosen path, those flows end up adjusting interest rates instead. When US rates rise, Singapore dollar rates tend to rise too. When US rates fall, ours tend to drift down. MAS has not raised or cut anything. The market has done it.
If Singapore rates simply copied US rates, you could read the Fed's range and know your mortgage rate. They do not, for two main reasons.
The first is the expected path of the Singapore dollar. If investors expect the Singapore dollar to strengthen over the coming months, as it does when MAS keeps an upward slope on its band, they will accept a lower interest rate on Singapore dollars. Part of their return comes from the currency gaining value. That is why Singapore dollar rates often sit below US rates even when they move in the same direction.
The second is local demand and supply of funds. If banks here have plenty of Singapore dollar deposits and not much demand for loans, short-term rates can sit lower. If they are short of funds, rates can be pushed higher. These local conditions can widen or narrow the gap with US rates for months at a time.
So the rule is: Singapore rates tend to move in the same direction as US rates, by a broadly similar amount over time, but with a gap that changes.
There is one more twist that catches people out. Financial markets trade on what they expect the Fed to do, long before it does it.
If traders become confident the Fed will raise rates at its next meeting, the prices of short-term US government bills adjust straight away. Singapore government T-bills, fixed rate mortgage offers and fixed deposit rates often shift as well. By the time the Fed announces the decision, much of the move has already happened. The decision day can then look quiet, because it was expected. Lesson 7.2, Separate what changed from what was expected, comes back to this.
Floating rate loans behave differently. As lesson 2.2 explains, most of them are pegged to an average of past overnight rates, so they catch up after the Fed moves. In practice Marcus and Grace often see fixed rate offers change first, and their own instalment change a few months later.
You can check all of this yourself. The Fed publishes the dates and decisions of its meetings on its website. MAS publishes SORA, the benchmark you will meet properly in the next lesson, including the three-month compounded version that most floating home loans use.
Before you go to the activity, decide what you expect to see. If the Fed raised its range, you would expect three-month compounded SORA to rise over the following months, by a different amount and with a delay, since it averages past rates. Write that expectation down, then go and look at what actually happened.
Find the dates of the last two Fed rate decisions and check how three-month compounded SORA moved in the months around them.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).