You’d probably woke up to this news today; the Fed has announced the biggest interest rate hike since 1994…but so what?
Let’s do a quick thought experiment and find out how it’ll affect us as investors.
But first, a quick background on how Singapore manages our currency:
How Singapore manages the value of SGD (and why it matters to you)
Singapore doesn’t manage interest rates but pegs the Singapore Dollar exchange rate against a basket of currencies. USD is one of the major currencies that the Singapore Dollar is benchmarked against. This means that Singapore has been inheriting the rising interest rates from the US.
As the US Fed increase their rate hikes, Singapore bond yield is likely to go up further.
Singapore’s 10-year bond yield is at 3.24% now and at a 5-year high. One year ago, it was at 1.49%. The increase might look small in terms of numbers but a butterfly effect exists – yield changes affect all other investments.
p.s. prefer to watch a video? I shared more here:
How the Fed Interest Rate Hike affects investors?
Let’s do a thought experiment and assume that the Singapore 10-year bond yield hits 5%. How would this change the financial landscape…and your investment performance?
1. REITs (and other dividend stocks) start to underperform
Most investors buy REITs because of their high dividend yields. Some of the more popular REITs have already saw price declines as the bond yield started climbed. These REITs are now yielding 5% and more currently.
If the SG bond yield hits 5%, REITs are not going to be attractive investments at 5% dividend yield. This is because the SG bonds are relatively safer investments. Some investors are likely to dump REITs and buy the bonds.
Why take more risk for the same return?
REITs yield has to be higher than the bond yield to justify for the additional risk. Hence, REIT prices should start falling until their yields go up to say 8%.
This principle will apply to all other dividend yielding stocks in Singapore. I picked REITs because they are generally higher yielding instruments and would hence suffer a bigger impact from rising bond yields.
2. Existing SG Bond holders would experience capital losses
This is because bond prices move opposite direction to interest rates.
The newer bonds are being issued at higher interest rates and to make lower-coupon bond attractive to a buyer in the secondary market, it has to be sold at a discount such that the yield-to-maturity matches the prevailing coupon rate.
Singapore Savings Bond (SSB) is an exception because the bond price is always fixed at par. And its interest rates would rise in tandem with the SG 10y bond yield.
Not sure how bonds work? Read this short bonds beginners guide.
3. Diversification wouldn’t save a portfolio this time
When both stocks and bonds are falling, diversification doesn’t work as well.
Assuming you have built a portfolio consisting of STI ETF for stocks and ABF Bond ETF for bonds in a 50-50 allocation, you would have lost 4.5% year-to-date (STI ETF is up 3.4%, ABF Bond ETF is down 7.9%).
You would have to wait past the inflationary period to see this diversification work again.
4. Interest on bank savings accounts will rise (but very slowly)
We should expect Singapore banks to increase the interest on all bank savings accounts but they will delay it as long as possible or increase as little as possible.
But once one bank raises the rest are likely to follow in order to keep customers.
5. Loan rates will increase across the board
It is more likely the loan rates will increase before the rates on bank accounts, and at faster rates. Be it business, car or mortgage loans, all these are expected to rise.
It is already happening – the 3-month SIBOR rate in April 2022 has doubled since Jan 2022. This would reduce consumption of high-value goods that needed loans and affect business growth.
In turn, it lowers the GDP growth of Singapore.
Fed’s biggest interest rate hike since 1994…but so what?
Don’t belittle this news, it will impact all our lives one way or another.
P.S. want more thoughts on the current markets? I share quick thoughts like these daily, join my Telegram group to receive these short Finbites.