In this article, besides discussing the outcome of the latest US Federal Reserve FOMC meeting in March, we give our view on where do we see interest rate going from here. This is especially important in view of what I’ve read in recent days that some brokers are touting fixed rate over floating rate at current levels. Which we do not agree. But first, let’s see what the Fed Chair has to say this time.
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US Fed’s Outlook
Jerome Powell has labelled the May’s surprising jobs report as that – a welcome surprise. But repeated its call that it’s going to be a long road from here and Fed will continue to stay aggressive and “deploy all tools, to the fullest extent for as long as it takes”.
The committee has unanimously forecasted no rate hikes in 2021 and only two Fed governors predicted possibility of rates hikes near the end of 2022.
Other notable conclusions from Fed policymakers:
- US economy will contract by 6.5% this year before rebounding to 5% growth in 2021 and 3.5% in 2022.
- Unemployment is expected to fall from current 13.3% to 9.3% by end of the year, and to 6.5% and 5.5% by end of 2021 and 2022 respectively.
- Its preferred inflation measure will drop to 0.8% by end of 2020, instead of the earlier forecast of 1.9%. This is a long way from Fed’s target of 2%. The committee thinks inflation will reach only 1.60% by 2021.
Fed will continue to buy about $80b in Treasury bill and $40b in mortgage-backed securities each month. Even as it mentioned the recent stock market rally, Fed expected millions of retrenched workers not to be able to go back to their jobs as businesses shut and consumers curb spending. But it hopes to avoid long lasting damage to the economy through its aggressive actions and by holding rates down for as long as needed to achieve its employment (4.5%) and inflation (2%) targets.
That’s indeed a long way to go.
First, I need to point out a clear distinction between stock market and interest rate. Traditionally there’s always been an adverse relationship – stocks go up when Fed cut rates, and vice versa. In recent years this effect has been further amplified with QEs or quantitative easing when Fed pump unlimited amount of liquidity into the financial system. That’s happening right now and that’s probably one of the biggest factor underpinning the post-covid stock market rally which has confounded experts.
Just like there’s also a dichotomy between stock market and the real economy. You hear of dismal GDP and unemployment projections for Singapore this year with government bracing for a deep recession. Yet the stock market is hitting new highs. Companies in US are cutting jobs, reporting steep drops in earnings, and withdrawing dividends and earnings guidance. Yet the Dow and S&P are powering ahead in a V-shaped recovery.
Many starts to think that maybe it’s indeed a V-shaped recovery for everything else and interest rates will go back up to 2% by next year. Let me put that idea to rest once and for all.
Why are we so certain? Because interest rate cuts can happen overnight, but not rate hikes. Can you imagine what happens if Fed were to announce a full 1% or 100 basis point increase in one FOMC sitting? Yes, the stock market will crash. No US President will allow that, even if Joe Biden wins. And where’s the justification to do such aggressive hikes – in an economic recovery phase that could stretch potentially longer than 7 years? I do not think any Fed Chair in his or her right frame of mind would choose to hike rates like that which is madness.
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So, the next question – let’s suppose the impressive US stock market recovery (barring a 2nd wave of pandemic which we hope not) is a pre-cursor to a real economy recovery in 2021, how long will it take to translate that to an “interest rate recovery”? If we manage to avert or reverse a global recession due to covid, trade-wars, deglobalization, etc, Fed might start to pull back stimulus slowly, starting with the end of the purchases or QE. They would err on the side of caution and choose to hold rate hikes for as long as possible. We’ve just heard from the Fed committee that they expect no hikes all through until the end of 2022.
Now Fed is always data-driven. Things can change depending on the economy. The stock market has pretty much discounted the rest of the year and is pricing in a strong economic recovery from 2021. Even if Fed is wrong and they start hiking rates a year earlier at end of next year 2021, at the likely pace of two hikes a year initially, it would be three more years before we get back to pre-covid levels with fed funds at 1.50%. That’s 2025.
Our Forecast – Interest Rate In Singapore
I said at the start of this article that we have heard brokers recommending fixed rate at 1.50% because the premium over floating rate at 1.30-1.40% is not much. The problem with that lies in the “not much”. We believe the “equilibrium rate” is not at 1.40% (we touch on this topic in our last article). It ought to settle closer to 1.20% eventually and we are hoping, just like in the last 2008 crisis, most people will be paying 1.00-1.20% on floating rates for the next few years (from 2009-2014). We believe the recent run-up in spreads on SIBOR home loans are overdone. A knee-jerk reaction from banks with a sudden plunge in SIBOR over a one month period. Indeed, one foreign bank has already cut the spreads back with a final effective rate at 1.20%! More ought to follow soon to compete for market share. In other words, we are saying fixed rates are still trading too high at the moment.
Based on the latest Fed statement, we usually adjust our forecast for SIBOR in mid-year. We still think that with fed funds at 0.05%, there’s still room for SIBOR to fall further here in Singapore. As of 8 June, 1-month and 3-month SIBOR are at 0.24925% and 0.54516% respectively. 1-month SIBOR should settle in the 0.15-0.20% range and 3-month SIBOR has greater propensity to fall from here and close the gap with 1-month.
We maintain our forecast for 3-month SIBOR to reach 0.25-0.40% level sometime in the year.
As such, floating rates we think will begin to trend down again to 1.20%. Any resistance is due to the absence of free market competition. Banks must become aggressive again to want to take market share.
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Let me explain why we go to such length to debate on this topic of fixed versus floating. Over the years here at MortgageWise, we have seen the same outcome repeat itself.
The problem with fixed rates is that – at the end of 2-year lock-in period, most people realised they are overpaying, as rates never really come up as high as initially thought.
The only time that fixed rates turn out to be the correct call was in 2016-2018. Those who locked down fixed rates then managed to keep their interest rates largely below 2%. We started changing our position to advocate SIBOR floating rate home loans at the start of 2019. Those who followed our advice then are having the last laugh now, locking down spreads of 0.25% and paying a ridiculous interest rate of 0.50%! The spreads may have run up especially in the last few months but it is still very realistic to expect refinancing to interest rates near 1.20%.
How do we know when to switch course to floating rate? We simply follow the interest rate cycles. We are starting to come out from a very low point into the next phase which could be a plateau on rates for a considerable time.
This is not the point in the cycle to switch to fixed rate home loan yet.
Before we end, I like to say this – it is always difficult to take the higher ground, or the contrarion view. For example, when there’s a lot of fear out there, it’s just very hard to convince people to buy REITs at 40% discount or to buy SIA shares when it was just $3.60 a few weeks ago. Likewise, it’s hard to convince people to take a bet on floating rate when fixed rates seem quite low at 1.50%. The recent experience when interest rates shot up to over 2% stays vivid in their minds. But it is during such times that you win big – defying the norms. We could have chosen the easy path here to advocate fixed rate and save all our breath. But our mission here, besides being a rates comparison site which is a dime a dozen, is to educate the market. We even stick our neck out with interest rate forecast which comes with risk. But like I said, we are contrarion and we live by that.
Start working with us today and save on interest costs as we watch the interest rate environment for you.
Since 2014, MortgageWise.sg has provided thought leadership in the mortgage planning space in Singapore, seeking to build trust with clients over the longer term rather than product-peddling for quick one-time deals. So, be it to refinance home loan, or to buy your next Singapore property, speak to our dedicated team of mortgage consultants here for the best home loan Singapore rates.