U.S. federal reserve

Do Exactly What U.S. Fed Does

The market heaved a sigh of relief last week following the latest speech by U.S. Fed Chair Jerome Powell at its annual Jackson Hole symposium where no timeline for tapering of bond purchases were announced.

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Stock markets were battered in the days in the run-up to Powell’s speech on the more hawkish tones emanating from several prominent Fed governors pushing for tapering to commence soon and end fast. Possibly to finish as early as Q2 2022 which then set the stage for Fed to hike its federal funds rate by next year June if necessary.

Indeed, Powell and his colleagues made great effort to de-link the two actions with repeated assertions: “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff,” Powell said in his speech.  He has also made clear that “rate hikes aren’t imminent as there’s still much ground to cover before the economy hits full employment”.

Tapering refers to Fed paring down its balance sheet which has grown from below US$3.8 trillion pre-pandemic to a behemoth US$8 trillion.  The Fed has extended QE (quantitative easing) or US$120b worth of asset purchases of treasuries and mortgage-back securities every month since covid-19 hit.  It now has to embark on bond sale programme expected to be over a period of 8-10 months in order to mop up this huge slosh of liquidity in the system.  It is widely accepted that tapering will precede and must be completed before the likelihood of any lift off in rates.

Even though markets responded positively with Dow and Nasdaq powering to record close after Powell’s speech, it remains to be seen in the coming weeks and months if reality might set in at some point. The market seem to have bought into the idea of no imminent hikes notwithstanding the bond sale, but brushed aside the fact that what the Fed has announced effectively amounted to a hastening of policy tightening.

Here’s why: In the aftermath of the first wave of covid-19 in U.S. in 2020, U.S. Fed vowed strongly to provide unlimited liquidity in asset purchases for as long as needed and to hold off any rate hikes until after 2023.  However with the spectacular V-shaped recovery, it has over the months pared down such accommodative stance with more Fed governors voting for lift off in interest rates by early 2023, going by the latest dot plots.  With inflation running red-hot due to supply constraints, Fed is now under pressure not to fall “behind the curve”.  The biggest clue is given by Powell himself who admitted that tests for “substantial further progress” has now been met.  So, tapering will start before the end of the year.  If it commences in November and takes 8-10 months for the Fed to finish up, this means the earliest that the Fed could be expected to hike rates from zero might come in Jun 2022.  That’s walking back on its accommodative schedule of “no earlier than 2023” (in other words 2024 onwards) by more than a year and a half!

Dice showing home loan interest rate can go either way up or down

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By attempting to start its bond sale quickly and to finish it much earlier than expected by mid of 2022, the Fed is preparing itself to be in a position to hike rates should inflation prove to be more than transitory – a position Powell has maintained in his speech.  This has implications for homeowners with a mortgage to review.

Even though the benchmark interest rate for mortgages in Singapore, i.e. the 3-month SIBOR or compounded SORA, may nudge up only slightly once tapering is underway, it is not expected to move up in any significant manner until such time Fed hikes rate from zero.  The fact that Fed might now be in a position to raise rates at least a year earlier than expected means there’s a chance we might see interest rates going up in Singapore by the second half of next year.

By attempting to start its bond sale quickly and to finish it much earlier than expected by mid of 2022, the Fed is preparing itself to be in a position to hike rates should inflation prove to be more than transitory – a position Powell has maintained in his speech.  This has implications for homeowners with a mortgage to review.

Homeowners with mortgages to review ought to take this as the signal and do likewise what the Fed is doing – get into position.  In the context of home loans, that means to ensure that you are out of any lock-in period by end of 2022 or no later than mid of 2023.  This is in order that you are free to renegotiate for the lowest fixed rate home loan with any bank should interest rate take off in a big way by then.

Fixed rates in Singapore have generally hovered in the 1.38-1.88% rangebound in the last decade since the financial crisis of 2008.  During the last ascent where Fed hiked rates from 2016 to 2018, it peaked at around 2.38-2.48%.  With the onslaught of covid-19 and with fed funds near zero, it has since fallen back a long way.  In fact, this year we have reached historical-low for fixed rates in Singapore with a couple of banks now offering 2-year fixed from 1.10%.  For sizeable loans of above one million, it can even drop to 1.05%.  Still, to derive the longest mileage on fixed rate and optimize interest savings, it’s imperative to be able to lock down fixed rates towards end 2022 or early 2023.

To balance things up, it’s not definitive that interest rates will rise in the coming years.  In his speech Powell did flag the new-term risk of the Delta variant, or for that matter, any other new variant to emerge from here.  There are also geo-political risks brewing from tensions in the middle-east, Taiwan Straits, to the cross-fire from a US-China trade war.  Not to mention the perennial risks in the financial system with an exploding U.S. budget deficit, a deflating US dollar, and a stock market on stretched multiples.  Should another economic crisis befall us, Fed might be forced to remain accommodative keeping rates down lower for longer.  That’s been very much the theme for most parts of the last decade.

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