(F) lady thinking about SORA vs SIBOR mortgage pegs

How To Position Your Mortgage With Inflation Expectation?

Amidst the current covid-19 resurgence in Singapore and Asia, the U.S. offers a glimpse of what we can look forward to in 2022 when we achieve herd immunity against the virus with at least 70% of the population vaccinated.  U.S. is slowly reopening its economy as more people are getting back to work places, restaurants, malls and even travel.  Some semblance of normalcy is returning.

With pent-up demand from reopening and supply chain disruptions causing import prices to rise, there is fear of rising inflation in 2H 2021.  First let us be clear.  We do not pretend to know if inflation will indeed be transitory, i.e. it will settle back down in 2022.  That’s one school of thought and the view of the U.S. Federal Reserve which has to repeatedly state its position as we have heard from the latest FOMC meeting.  Another school has it that the Fed is absolutely wrong and this time around it’s going to be different – how can there not be lasting inflation when M2 money supply in the U.S. has exploded by 33% since pre-covid days, with all the stimulus checks credited into bank accounts of millions of Americans.   The fear is that Fed will be behind the curve and slam on the brakes in a series of rate hikes from 2022 when inflation escalates.

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For the benefit of those new to interest rate cycle (see the chart below), Singapore’s benchmark interest rates (the 3-month SIBOR and its replacement the 3-month SORA compounded) track the Fed funds rate closely.  Hence, to know the direction of which way your Singapore home loan interest will move, watch the US Fed on its interest rate policy.

As we begin 2nd half of 2021, in view of such inflation fears, how should one “position” his or her mortgage when it comes up for renewal?

Mortgage strategy is not just about selecting the home loan package with the lowest headline rate, rather it’s about putting oneself in the most advantageous position to capitalize on all the ups and downs in the interest rate cycle.  Think of it somewhat like buying a property – negotiating with the seller to shave $20,000-$50,000 off the purchase price, will not help if one buys at the height of the property cycle and peak prices come crashing down soon after leading to negative equity (sale price below the mortgage).  Conversely, one can overpay slightly to snatch a good deal during the property lows of 2009 and watched how prices almost doubled over the next 10 years!

As interest easily make up one third of your total monthly repayments over the entire course of the mortgage (no matter how many times you switch banks), riding the interest rate cycle correctly can save you a significant sum of money.

Mortgage strategy is not rocket science: lock down fixed rate on the up cycle, switch to floating rate when the cycle reverses, and stay nimble when it trades sideways or when unsure of its direction.  At the same time, manage all the costs associated with mortgages like legal & valuation fees and avoid paying unnecessary fees like prepayment penalty, cancellation fee, penalty due to sale, etc.  However, it’s the execution and knowing when and what to switch to that makes it challenging.

Mortgage strategy is not just about selecting the home loan package with the lowest headline rate, rather it’s about putting oneself in the most advantageous position to capitalize on all the ups and downs in the interest rate cycle.

Let’s take a look now at where we are in the interest rate cycle and extrapolate some possible trajectories for fed funds rate:

First notice how interest rates in Singapore track and follow closely after the U.S. fed funds rate (the black line).  Though 3-month compounded SORA (the orange line) was just launched in 2020, we have “reconstructed” its historical path from Oct 2005 using data provided by MAS on the same SORA Index methodology. (We use the term 3-month SORA and 3-month compounded SORA interchangeably).

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There are distinct phases in the cycle of plateau, false start, ascent, decline and we are now back to the plateau phase since covid-19 outbreak in 2020.  We suggest three most likely trajectories for fed funds rate from here (Singapore interest rates will follow thereafter):


Trajectory 1
Fed is proven wrong.  Inflation rises in 2022 and stay up too long for Fed’s liking.  U.S. economy bounce back with a vengeance with new vaccines working to put the virus strains under control.  Unemployment rates plummet to near recent year lows as more people find work with wages also rising quickly in a tight labour market.

In this scenario, Fed is forced to bring forward its plan to first taper off on bond purchases and then start hiking rates at a faster pace with the first one coming in 1H 2022.  This to be followed by a hike almost every quarter from Q4 of next year.

Trajectory 2
Fed turns out to be right.  Inflation is transitory and begin to wane in 2022.  U.S. economy continues to recover albeit at a slower pace than anticipated.  There are occasional flare-ups in the virus or new variants leading to tightened measures and reduced demand.  Fed gradually tapers off on bond purchases for most of 2022/2023 but largely kept to its promise of normalizing rates only from 2024.

Trajectory 3
Deflationary environment for the US economy, which has been the case in the last 25 years, persists.  The massive slosh of liquidity in the system, with Fed printing money to the tune of US$8 trillion to-date in its balance sheet, continues to drive up equities and asset prices globally.  But there is no tick up in inflation.  As a euphoric market continues to chase after cryptocurrencies, EVs (electric vehicle) stocks, meme stocks (like GameStop, AMC), or other stocks of crazy valuations, the day of reckoning comes sooner than expected.  A stock market crash wiping out wealth and jobs will warrant Fed to continue to remain accommodative for a good many years to come.  This time it might take even longer than the last plateau of 6 years from 2009 to 2014.

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As the debate rages on regarding how transitory is inflation, in other words between trajectory 1 & 2 above, we might end up with a trajectory 3.  The truth is no one can say for sure what will happen until it becomes hindsight (on a chart).  We use a chart-based approach in mortgage planning and strategy, along with some scenario planning guidance, as that gives the most accurate forecast on interest rate.  By studying closely how interest rates actually move in the past, we can deduce some possible paths forward.  And remember on a chart it can only move in three directions – up, down, or sideways.

And it’s also on a chart that we can dispel fallacy about rising rates – it’s never going to spike in a straight line up within months.  Not even a year.  It will take at least three years or longer (2016-2018) each time the cycle turns up before hitting the next peak.  And there may be false starts along the way where Fed might suddenly do some “insurance rate cuts”.

Here’s some concrete advice for homeowners:
As we are still unsure of the path of interest rates from here, it’s best to stay nimble and go for mortgages with shorter lock-in periods.  We think it’s not absolutely critical whether one opts for fixed rate or floating rate home loan at this point, as the gap between the two are so close.  More importantly, choose one with a 2-year lock-in instead of 3-year.  Give yourself an earlier exit point to review how events would have unfolded and which path the interest rate cycle has taken on eventually.  Don’t worry, it’s not going to be too late to lock down a 3-year fixed rate later on should trajectory 1 takes shape.  Remember what we’ve just discussed about the speed of rising rates and false starts?  It’s going to take time.  In fact, you might just find your timing spot on to lock down a 3-year fixed rate right at the start of the next ascent, giving you full ride to safety for the entire 3-year upswing cycle.

Not forgetting we are also now at toppish levels when it comes to property prices, many may want to sell their existing homes for bigger WFH spaces.  There’s added advantage in going for floating rate home loan where there are more packages to choose from which comes with features like “waiver of penalty due to sale during the lock-in period”.  That saves you 1.50% penalty on the outstanding loan when you have to redeem the loan in full with a sale (there’s no transfer of loan to another property in Singapore, unlike in the U.K. for example).  On a typical loan of $750,000, that’s $11,250 saved!  Put it another way, if your current interest rate is near 1.50%, you are paying another full year of mortgage interest to the bank as a parting gift.

More importantly, choose one (home loan package) with a 2-year lock-in instead of 3-year.  Give yourself an earlier exit point to review how events have unfolded and which path the interest rate cycle has since taken on.

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