Did you know that our lifestyles have been empowered by artificially repressed interest rates since 2008? The federal hike will change all that. Here's how it will affect you.
The countdown to Doomsday has begun. Come 17 December 2015, there is a high chance the United States Federal Reserve (the Fed) will make the decision to start raising interest rates. This will impact almost every country in the world, Singapore included. Here’s how it can cost you serious money:
What is the Rate Hike and Why Should You Care?
In 2008, a series of financial disasters caused severe damage to the American economy. This in turn sent shockwaves through foreign markets, and resulted in the Global Financial Crisis.
In order to speed recovery from the crisis, the Fed reduced its interest rates to zero per cent. Without getting into the subtleties of central banking, we’ll summarise the effect for you:
Almost everywhere around the world, interest rates fell to astronomically low levels.
Loans became a lot cheaper, particularly home loans. In Singapore, this created a surge in residential properties, and caused businesses to expand rapidly (when loans are cheap, businesses tend to borrow aggressively to expand).
It was good times all around--from 2008 to the present, home loan rates ranged between 1.7% and 1.9%, making bank loans even cheaper than HDB loans. Business loans also became cheaper, and commercial properties cost less to rent and buy.
In effect, much of our lifestyle has been empowered by artificially repressed interest rates since 2008. Without the Fed lowering its rates, businesses would have been slower to expand, weak businesses may long ago have folded, and our housing would be less affordable.
Now however, the Fed is on the verge of raising interest rates once again. This is based on rising employment and wages in the United States, which signals that their economy has recovered. The Fed doesn’t want to continue the policy of artificially low rates, as doing so for a prolonged period could cause runaway inflation.
What Will Happen to Singaporeans When Interest Rates Rise Again?
Even the threat of the rate hike is enough to affect our economy. Over the past week, for example, the Straits Times Index has already fallen 1.5%. Some other effects to brace for are:
- Increased volatility in the equities market
- Forex rate fluctuations
- Higher home loan rates
- Greater debt burdens on businesses
1. Increased Volatility in the Equities Market
The stock market is already in a flurry over the coming rate hike. If the rate hike does happen (wait for Thursday), we can expect a lot of volatility in the markets. This can affect you even if you don’t directly invest in stocks.
For example, insurance products such as Investment Linked Policies (ILPs) put your money into sub-funds. A rate hike could drastically affect the performance of these sub-funds, and impact your bonuses and payouts.
If you have invested money into mutual funds, now is a good time to call your fund manager or financial advisor, and determine the new level of risk you’re facing.
Investors in REITs should also be on alert. Singapore REITs have a low gearing ratio, so the odds of a REIT imploding are unlikely. However, profitability may be affected. REITs operate commercial properties in which the loans are pegged to SOR rates (see point 2 for the significance of this.)
Turbulence in the stock market is due to the sentiment - true or otherwise - that a rate hike will cause most businesses to become less profitable, or possibly even fold in the face of rising debt burdens.
2. Forex Rate Fluctuations
Federal interest rates have a direct impact on the strength of the US dollar. As the Federal interest rate rises, inflation decreases in the American economy. This causes the US dollar to appreciate.
This year, we are faced with a double whammy: China is allowing the yuan to devalue, for a variety of reasons. Chief among them are having the yuan included in the IMF’s basket of reserve currencies, and to boost its ailing exports.
The devaluation of the yuan makes Chinese exports more competitive, as their goods become cheaper to buy. As such, several other Southeast Asian currencies have followed suit, as ASEAN tries to stay competitive with them.
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Singapore doesn’t fiddle with its currency in this way (the Singapore dollar is pegged to a basket of 10 different currencies), but there is a possibility that the Singapore dollar could weaken further with other regional currencies.
All of this is a headache for foreigners looking to remit money home, as the fluctuating exchange rates could cost them a lot of money. Singaporeans who have dealings in the United States (e.g. children studying abroad there) could face the prospect of much higher costs. Tuition fees in American Universities, for example, are effectively higher for Singaporeans due to the strengthening US dollar.
Now would be a good time to contact a Forex broker for help, if you are in a situation where you need to deal with US dollars. Foreigners working in Singapore might want to consider a multi-currency account, such as the Citibank IPB, to minimise the impact of currency fluctuations.
3. Higher Home Loan Rates
The rate hike will drive up SIBOR and SOR, both indexes to which home loans are commonly pegged. This doesn’t look good for newly-wed couples looking to purchase their first HDB flat.
Those with SOR based home loans would do well to refinance as soon as possible, as SOR is a Forex implied rate (it is based on the exchange rate between the Singapore dollar and US dollar). Last Friday, the SOR rate was a three month high of around 1.59168%, which is an almost fourfold increase since 2014. DBS predicts that SIBOR rates, which are currently at 1.2%, will reach 1.4% by early 2016.
There’s already a rush of homeowners trying to lock in lower rates, and it’s a good time to join them. UOB currently has one of the lowest home loan rates at 1.68%, and several other banks are expected to put up more fixed rate packages as home loan solutions.
4. Tighter Liquidity for Businesses
Higher interest rates mean businesses will be more reluctant to expand. Businesses with existing loans will find interest rates eating into their bottom line, and one of the bigger worries is with already over leveraged energy companies.
Already low oil prices (crude oil has fallen to USD$37 a barrel) are compounded by speculation that Iran will produce more oil, thus adding to the oversupply situation. These low commodity prices, coupled with increased debt burdens, might spell trouble for companies in the energy sector (you can be indirectly affected, if your mutual funds or ILPs hold equities in these companies.)
On a more immediate level, we may see an indirect impact on employment and wages. Businesses might have to cut back on hiring and bonuses, due to slower expansion and rising loan repayments. Smaller companies might be the worst hit, as they often lack the capital to expand without resorting to borrowing.
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