How High Will Mortgage Rates Go?

2022 so far has been a most eventful year for the rest of the world. So far, we’ve had a sharp downturn or two in the financial markets, high and rising inflation, a world economy recovering from years of Covid-19. And then there are supply chain disruptions, the beginning of an interest rate tightening cycle, and what else? Oh, of course, there is that war in Ukraine, threatening to choke global supply chains and energy supplies. But what it really comes down to for many of us is this. How high will mortgage rates go as a result of all this? That is really all about inflation, interest rates and how these rates in the US affect us in Singapore.

Will Mortgage Rates in Singapore Reach for the Sky?

Let’s Start By Looking At US Interest Rates

Just a couple of weeks back, the US Federal Reserve embarked on the first of a series of increases in the Fed Funds target rate, raising it from 0.25% to 0.50%. This is the first time since the end of 2018 that US interest rates have been raised. This time round, rates could go all the way up to 2.75% to combat inflation in the US. As everyone knows, interest rates in Singapore are closely tied to US rates. Looking at history, the last times the Fed raised rates was in 2016 to 2018, and in 2005 to 2007.

A History of US Interest Rates

Looking back at history, it appears that the possibility of US interest rates being raised progressively over the next 2 years to 2.75% really looks no worse than what it was back in 2016 to 2018 (Fed Funds target rate peaked at 2.5% in 2018, money market rates above were a little higher), and certainly would be much milder than the episodes back in 2006 to 2007 and also back in 1999 to 2000. So, no big deal it seems. We’ve all been there before.

So How Does This Affect Singapore Interest Rates?

If US interest rates go all the way up to 2.75%, what happens in Singapore? For a start, we can look at what happened in Singapore back in 2016 to 2018, to try to gauge how high interest rates in Singapore will go.

A History of Singapore Interest Rates

It does appear that interest rates in Singapore have tracked those in the US in the past. Not exactly, nor all the time, but the peaks in the past have occured at the same time as interest rates in the US have peaked in the past. Why is this so? This is something some of us may have learnt back in school – Covered Interest Rate Parity.

Interest rate parity is a no-arbitrage condition representing an equilibrium state under which investors interest rates available on bank deposits in two countries. That’s quite a mouthful, so it is easier to illustrate this using an example.

1. Suppose you borrow S$1.35 million at an interest rate of 2%, covert it into US$1 million, and put it into a US dollar bank deposit at an interest rate of 3%
2. At the end of 1 year, you owe S$1.377 million to the bank you borrowed from, and you will get back US$1.03 million from your US dollar deposit
3. If the USD-SGD exchange rate has not moved in the past year, then you’ll have made a profit, since it is cheaper to borrow S$ at 2% and better to deposit US$ at 3%

Now, if it were so easy to make money this way, you can be sure everyone and his sister will want in on this, borrowing S$ to sell, and converting it into US$ to deposit. There obviously isn’t so much S$ in the world that can satisfy this. So the only thing which can balance this, is for the S$ to strengthen over time, negating the extra 1% which can be earned on US$ deposits over S$ borrowings.

Alternatively, the exchange rate can stay constant. But to balance this, interest rates in both countries will need to equalise at either 3% or 2%, to prevent the mad rush of speculators trying to earn that 1%. Since the US is a much bigger economy than Singapore, Singapore’s interest rates needs to match the US interest rates.

And that is why the interest rates in Singapore, and hence mortgage rates, will have to follow what is happening to US interest rates. Especially so because the exchange rate is the main tool for monetary policy in Singapore. If we didn’t match the rise in US interest rates, there’ll be expectations that the S$ will strengthen. And this will strangle all our export industries to a slow and painful death as we become more and more uncompetitive internationally.

How High Will Singapore Mortgage Rates Go?

So for those of us on floating rate mortgages e.g. SORA or SIBOR pegged loans, our fate is sealed then, now that our prophecy is read? Will SORA or SIBOR eventually go all the way up to 2.75%, just like interest rates in the US will, and so we will end up paying the 2.75% + 0.65% spread on our mortgages?Not quite. Looking at the chart of Singapore interest rates and comparing them to US interest rates, you’ll notice that in the last interest rate cycle, Singapore rates peaked at 2%, less than the 2.75% of US interest rates. And in the 2006-2007 cycle, rates in Singapore peaked at a level almost 2% below US interest rates! What’s going on here? Whatever happened to good ol’ interest rate parity?

Well, it is still interest rate parity in action. Remember that Singapore manages the exchange rate instead of interest rates? Every once in a while, the Monetary Authority of Singapore will allow the S$ to strengthen. And when it does, interest rates in Singapore can be held at a level below their US counterparts, while maintaining interest rate parity. the chart below shows what happens:

Singapore Exchange Rate Policy

Back in the 2016-2018 interest rate cycle, Singapore initially maintained a policy of keeping the exchange rate constant, i.e. 0% slope of the S$NEER policy band, so Singapore interest rate tracked the US ones. However, this was changed in 2018 to a rising slope for the S$NEER policy band. While the MAS never announces the precise slope, historically, it is around 0.75% to 1% per annum. Which means that in late 2018, as US interest rates peaked at 2.75%, Singapore could keep the domestic interest rates at a level below US interest rates.

So what is going to happen this time round? Over the whole of the pandemic period, the MAS has kept the policy band at 0%, that is, not looking to strengthen the S$, which was the appropriate action to take for a weakened economy. However, in January, it announced a tightening of monetary policy, which is equivalent to letting the S$ appreciate again. This means that interest rates in Singapore will track the US rates, but eventually will peak at a lower level. It is not obvious right now, because Singapore interest rates are currently higher than the US Fed Funds rate, but over a longer period, this should revert.

Therefore, given the exchange policy stance now, the interest rate index used for floating rate mortgages is likely to peak at 2% (just like 2018). This means that those on floating rate mortgages will be paying mortgage rates of around 2.5% to 2.75% (depending on the spread on the loan) at the peak of interest rates, perhaps in mid 2023 onwards.

Assuming MAS’ exchange policy stance remains unchanged, Singapore interest rates will peak at around 2% in 2023. Borrowers will then pay between 2.50% to 2.75% on floating rate mortgages.

What about Fixed Rate Mortgages?

Then, there are those who are thinking of converting their floating rate mortgages to fixed rate mortgages, so as to protect themselves against the higher interest rates. Currently, fixed rate mortgage rates are around 1.65%, so these rates are higher than the floating rate mortgages for now. Given the rising path of US and Singapore interest rates, how high will fixed rate mortgages go?

This is a somewhat harder question to answer, since the fixed rate mortgages depend on the cross currency swap rates between the S$ and US$, for very much the same reasons as the interest rate parity argument described above. Only this time, we are not talking about short term interest rates, but 2 or 3 year interest rates instead. And this data is not so easy to obtain. But what is easier to obtain are the US Treasury Bond yields:

US 2 Year Treasury Bond Yields

So back in 2018, when the US Fed Funds target rate hit 2.50%, and the short term interest rates in the US hit 2.75%, the 5 year Treasury bond yields almost touched 3%. In a way, long term bond yields are the aggregate of short term interest rates. If interest rates go to 2.75% and stay there permanently, the bond yields will also be a little above 2.75%. So, if the Federal Reserve’s plans go ahead, and interest rates in the US hit 2.75% within the next 2 years, then the bond yields will probably go up to 3.25% or thereabouts.

How does this translate to Singapore fixed rate mortgages? In 2018, at the peak of the US interest rate tightening cycle, fixed rate mortgages in Singapore were around 2.88%. So with this round of tightening going a little higher than the previous, we can expect fixed rate mortgages to reach 3%, in line with what we see from history. So if you are thinking of converting your floating rate mortgage to a fixed rate one, where fixed rate mortgage rates are right now, it is probably the right time to do so, especially looking at how quickly the 2 year US Treasury bond yields have shot up recently.

We can expect fixed rate mortgages to reach 3% at the peak of this interest rate tightening cycle, in line with history.

But how long will the higher interest rates persist for?

While switching from a floating rate mortgage to a fixed rate one sounds like the obvious thing to do, the question of whether to pull the trigger is really “how long will the higher interest rates persist for?”. If interest rates are going up to 2.75% and staying at that level forever, then the answer is obvious. But the history of US interest rates show us that the recent rounds of interest rate tightening (in 2005 to2007, and in 2016 to 2018) are pretty short, as events have overtaken the path of interest rates time after time.

The longest span when rates were high is probably in the mid 1990s. This period starts with Greenspan’s famous “irrational exuberance” remark in 1995, and ends following the 9/11 attack on New York in 2001. Thereafter, the Global Financial Crisis of 2008 ended the 2006 to 2007 round of tightening, and the Covid-19 pandemic ended the 2016-2018 round.

This time round, it may well be the war in Ukraine which interrupts the interest rate tightening cycle. Especially if the war, combined with soaring energy prices, ends up bringing about a recession. Indeed, the current US Treasury yield curve, with the yields being roughly the same from the 2 year, 5 year and 10 year maturities, indicate that the tightening may be short. All these bond yields show that interest rates are probably going up very quickly, and may hit 2.75% before the end of next year. And that is not surprising, seeing how quickly inflation is shooting up in the US, driven by demand factors rather than supply factors.

Core Inflation in the US (excludes energy prices which are supply side shocks and may be transitory)

But if interest rates are going up quickly, and staying high, then bond yields should be closer to 2.75% already! Remember, bond yields are the aggregate of short term interest rates, weighted by time. But the 5 year and 10 year yield hovering at less than 2.5% for now indicates that the peak of the interest rate tightening is likely to be short. Maybe for a year or two only? If that is the case, then hanging on to that floating rate mortgage (especially if you’ve locked in a good spread), may be the optimal course of action to take.

If the US Treasury bond yield curve is correct, and this interest rate tightening cycle will be short lived, then hanging on to your floating rate mortgage might be optimal.

*See also our latest on Should I Pay Off My Mortgage Before Retiring Early?

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