US Fed has shown resolve to get “ahead of the curve” in its latest rate hike following June’s FOMC by moving the federal funds rate up by 0.25% to a range of between 1% and 1.25%. This is notwithstanding recent data of softening inflation in May.
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What is also significant this time is the announcement of its plan to roll back or pare down of its huge Treasuries & mortgage-backed securities holdings starting from as early as this year. The holdings were result of QE (quantitative easing) measures taken to support the economy after the Great Recession in 2008 which has since swelled the Fed’s balance sheet from US$1 trillion to over US$4 trillion. Janet Yellen conceded that the Fed will likely maintain a much a higher level of securities at US$2.5 trillion on its balance sheet even after selling off its assets in a measured pace over the next few years. And it has announced plans to begin rolling off its books US$10 billion every month comprising US$6 billion in Treasuries and US$4 billion in mortgage assets and this monthly cap will be increased gradually every quarter until it hits a rate of shedding around US$50 billion every month.
Some key data released by Fed in June FOMC were:
- Unemployment rate fell to a 16-year low of 4.3%. As this pace is much quicker than what Fed initially projected, they now moved their foreast for unemployment to settle at 4.2% for the next two years. At below 4.5%, this is essentially an US economy already in full employment.
- What is puzzling though is wage growth remains tepid against a tight labour market. However this time round it seems most Fed committee members believe the drop off in inflation and weak wage growth are just temporary blips which will pick up soon.
- As inflation has softened, Fed lowers its forecast for core inflation which strips out food and energy prices for 2017 from 1.9% to 1.7%, but maintained its confidence that inflation will shift towards its longer-term target of 2% from 2018 onwards.
- Fed also raised its GDP forecast for 2017 slightly to 2.1%
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With US funds rate at over 1% now, all eyes will be on how soon the benchmark interest in Singapore, ie. 3-month SIBOR, picks up over the next few months. It is now harder to predict that as we have observed an anomaly over the last two rounds of US Fed hikes since December 2016 when USD/SGD actually went south after each rate hike. This is a depart from the norm when interest rate hikes in US leads to capital flight out from Asia, a strengthening of USD and a drying up of liquidity in the banking system here which is what drives up borrowing costs in interbank eventually. Some plausible explanations could be:
- A generally-weak local economy where banks are finding it hard to lend out their excess funds which is likely the key reason for why SIBOR trade range-bound at 0.90% to 1.00% for the past year
- Structurally-depressed oil prices at less than half the level it used to trade at, translating into reduced energy prices and a key reason why inflation is finding it hard to reel its ugly head in recent years
- Globally the continued search for yield goes on with liquidity abound and the general aversion to risk assets after the Great Recession and a greying population in matured economies.
We are not economist. It is hard for us to tell how these various forces interplay and how much it will drive the pace of inflation in the US, a key determinant we look at, as well as how soon the traditional correlation between the funds rate and SIBOR will resume. With US Fed commencing its asset sale plan in the next few months, we believe this might be the crucial step in normalizing rates as liquidity gets mopped up slowly from the global system. Much the same way how the three rounds of QE itself started to flood the system with liquidity creating deflationary pressures, asset bubbles and the global search for yield, and disrupting traditional financial models. However, this unwinding process will take time.
With this latest move by US Fed, and now that the French election in May did not result in any risk event with EU remainining largely intact and in fact emerging stronger than before, we need to revise our forecast here from two hikes in US to three for 2017. This will be in line with Fed’s own forecast of three hikes this year with two already in the bag. All eyes will be on the next hike in September FOMC.
However, in view of the temporal break in correlation between the funds rate and SIBOR in Singapore as we have discussed earlier, but keeping in mind a slowly-improving local economy with a pickup in external demand, we are also revising our target for SIBOR to hit near to 1.25-1.30 level instead of the previous 1.50.
Even with a 25 basis point climb in benchmark interest, it would bring the prevailing mortgage interests to 2% level for most homeowners. Given how fixed rate packages are still at 1.48 to 1.68% today, it may be a good time to take action today before rates starts to rise again. Contact our mortgage consultants for an obligation-free chat.
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