The bf and his thoughts on SGD
My view in two paragraphs : I think that MAS policy will be increasingly ineffective if we head into an environment of weak domestic growth and/or rising US rates. This is mainly because the SGD NEER is managed against a basket of currencies but yet our interest rates are implicitly influenced only by one currency in the basket (USA). There are various permutations of scenarios (Rising USD, Rising US rates, Weak domestic consumption) can lead outcomes where the desired transmission mechanism of MAS policy is weakened by counter productive moves in domestic interest rates (that is inversely influenced by MAS FX policy and external factors) What's behind my view: MAS reduction of the slope of the NEER bands gives the SGD more room to depreciate against the USD over the next 12-18m. While the Dollar index looks overbought in the short run I am still fairly confident that the USD will retain its strength given monetary policy divergence that is occurring vs other majors. A strong dollar will mean that the other currencies in the NEER basket will also have depreciated against the USD. This therefore will give the SGD room to depreciate vs. the USD whilst still appreciating against other currencies (EUR, JPY, MYR, IDR) and hence still appreciating on a NEER basis" MAS is caught in a tough spot. While the objective of it's policy move is to counter deflation. Decreasing the slope of the SGD's NEER bands has resulted in the side effect of increasing local interest rates , tightening domestic liquidity etc.. this effectively weakens the it's policy transmission mechanism of its original move. Why does local i/r increase? SOR = USD rates + Forward points on USDSGD. Markets expectation of SGD depreciating vs. USD, reflected by excess demand for USDSGD forward leads to basis and which increases Forward points on USDSGD! Thus SOR rate increase ! Why am I concerned about it? I do not have a strong view on inflation and GDP growth. However, it seems that MAS policy tools may rather ineffective in a range of scenarios where domestic interest rates move against MAS policy. This is because Singapore's household debt levels has rise to ~75%+ GDP, and household debt to income is 2.3x vs 1.9 (2008) and one should not take our increased leverage for granted. Scenarios where MAS has policy is weakened: 1) Continued weakness in Singapore's economy and/or deflation 2) Rising USD and Rising US Fed funds rate environment In any of the aforementioned scenario's, MAS policy tools will become increasingly counter productive.In scenario: 1) MAS likely response would be to decrease the NEER slope again. Once again, this would lead to SOR and SIBOR rate increase which increases debt service cost and weakens local consumption growth (via, Property price change- wealth effect, higher borrowing cost) . The more MAS "eases" on its FX policy, the higher local interest rates will move and the tighter domestic liquidity becomes, hurting certain domestic segments of our economy. 2) The SOR will increase from both the forward point component as well as US Rates. This could potentially have the impact of an aggressive rate hike cycle on the local economy. MAS will be unable to control domestic interest rates and has to hope that macroprudential measures that were put in place earlier (related to housing) will be enough to prevent the a debt bubble from exploding To put things in perspective, Singapore is still an external dependent economy and at the current state, the net impact of MAS NEER slope shift should ("in Theory") be to stoke some inflation. i.e higher import prices and increased exports should outweigh the side effect of rising local interest rates hurting domestic consumption. They key is that our monetary policy has weak spots (such as those scenarios mentioned above) and we will need to see other measure (i.e. Fiscal Policy , Macroprudential ) being used to stabalize the economy.
