NEWS ANALYSIS

Faster US rate hikes to have mixed impact on Singapore

One concern for Singapore and the region is the prospect of investment funds flowing out to US-dollar assets

Singapore

THE United States Federal Reserve's decision to step up the pace of interest rate increases signals its optimism about the economy but will likely have a mixed impact on Singapore and Asia.

On the one hand, a stronger US economy spells good news for regional exporters. However, higher rates will push up borrowing costs in Singapore and the region.

The risk that interest rates might rise even more quickly than expected is also fanning fears of capital outflows from the region, which could lead to market volatility.

These uncertainties come on top of worries that escalating trade tensions could derail global economic growth.

The US Federal Reserve hiked its benchmark short-term interest rate a quarter percentage point on Wednesday.

The move brings the federal funds rate - which influences rates for mortgages, credit cards and other borrowing - to a range of 1.75 to 2 per cent.

In addition to the rate hike, which was widely expected, the Fed also released interest rate projections that implied two more rate hikes instead of one in 2018 and four rate hikes in 2019 instead of three.

The shift reflects a strengthening US economy, where unemployment has fallen to its lowest level since April 2000 and one of the lowest levels since World War II. At the same time, stock markets remain close to record highs and inflation has accelerated.

The Federal Open Market Committee's statement stressed that rising interest rates were unlikely to derail economic growth.

David Buckle, the head of investment solutions design at Fidelity International, said the US has recovered since the global financial crisis though it remains to be seen how long this strong growth can be sustained.

"In my opinion, the US is close to normal. That's been the case economically for a while, but with a 2 per cent interest rate, expected to reach 2.5 per cent by year-end, monetary policy is also close to normal," he noted.

"I don't significantly disagree with the Fed's outlook for 2018, but Fidelity's leading economic indicator is suggesting economic growth won't stay as strong as it has been, in which case I'm not sure the Fed will be able to deliver the 2019 interest rate increases."

Bank of Singapore chief economist Richard Jerram thinks the Fed will need to hike by more than it is projecting, given that it sees US economic growth running above trend as far out as 2020.

"The risk is that inflation comes through more rapidly than expected over the coming year, which forces the Fed to hike more than once per quarter," he noted.

"This would drive expectations that rates are going well beyond 3 per cent and would highlight recession risk in 2020 as the Fed struggles to cool growth in order to limit the overshoot in inflation."

For Singapore, higher US interest rates mean higher borrowing costs for households and companies. These include rates on mortgages, credit cards and corporate loans, and also bank savings accounts, which will be a boon to savers.

The three-month Sibor, or Singapore interbank offered rate - which is used to price home loans - remained almost flat at 1.52038 per cent following the Fed rate hike announcement.

Still, this is the highest the three-month Sibor has been since 2008 during the global financial crisis.

The Sibor is typically highly correlated with US interest rates and has been rising in tandem with Fed hikes.

"It's a double-edged sword (for Singapore)," said Maybank Kim Eng economist Chua Hak Bin.

"The hikes come on the back of stronger growth, which is positive. But as a result Singapore's short-term interest rates are going to climb, which could impact property market sentiment as well as companies that are highly-geared."

Still, the impact of higher interest rates on Singapore's growth is likely to be limited for now, Dr Chua noted.

"Rates are still relatively low and not likely to bite that much. When the Fed funds rate approaches 3 per cent in late-2019, Singaporeans might feel it a bit more."

Another concern for Singapore and the region is the prospect of investment funds flowing out.

Higher rates prompt investors to move money out of emerging markets into US dollar-denominated assets, putting pressure on Asian currencies and asset markets.

Something similar happened in 2013, when the Fed announced that it would wind down its policy of pumping money into the financial system through aggressive bond purchases.

Many investors pulled money out of Asian economies, resulting in what has been called the "taper tantrum". Asian currencies weakened against the US dollar as a result.

Dr Chua also flagged the risk of a global trade war, given escalating tensions between the US, Canada, China, the European Union and Mexico over trade.

"If trade war breaks out, that will hit growth. The outlook very much depends on how trade worries work out," he added.

READ MORE: Hawkish Fed spooks Asian markets

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