What now for mortgage rates? Higher, or lower?
A bit more than 3 months ago, we posed the question “How high will mortgage rates go?“. Our conclusion was that at the peak of the interest rate tightening cycle (which may be a little after the peak of the inflation cycle), floating rate mortgages will be around 2.50% to 2.75% (broken down into a base floating rate or around 2% and a spread of around 0.75%). Fixed rate mortgages, on the other, would peak at around 3%. What has happened in the past 3 months is that fixed rate mortgages have already hit the level forecast, although floating rate ones have not, and we are still some way from the peak of the interest rate tightening cycle. So, what now for mortgage rates? Higher, or lower?
Are mortgage rates going higher?
How high are mortgage rates right now?
Here’s what mortgage rates look like right now:
Singapore Mortgage Rates
What has surprised us even more than the apparent accuracy of the forecasts we made, is the speed at which this has occured. After all, the peak of the interest rate cycle was announced by the US Federal Reserve to be towards the end of 2023 at 2.75% back in March. However, the pace of inflation in the US recently seems to have forced the Federal Reserve’s hand into making a 75 basis point hike to the Fed Funds target rate (to 1.5% in June) and raising the forecast peak of the interest rate tightening cycle to at least 3.25% by the end of 2022!
But with the benefit of hindsight, we should not be too surprised. After all, if the US interest rates are forecast to reach more than 3% by the end of this year, then mortgage rates here will follow suit. But there is something else surprising going on here.
Why hasn’t the stronger SGD helped us keep mortgage rates lower?
- The liquidity in the Singapore money market, especially for long term borrowing and lending (i.e. more than 6 months) is quite limited. Banks usually swap SGD for USD and vice versa to fund and lock in interest rates for long term loans.
- The interest rates in the USD for SGD swap market are determined by the expected exchange rate in the future. If we expect SGD to appreciate, SGD interest rates will be lower than the USD ones by the amount of appreciation
- So if we expect SGD to appreciate by 1% a year, SGD interest rates will be 1% lower than the USD ones.
Now, the Monetary Authority of Singapore (MAS) announced a tightening of monetary policy in January, and again in April. This is equivalent to letting the SGD appreciate. So this should help to slow the rise of interest rates in Singapore. But this doesn’t seem to have happened so far. By all accounts, the MAS has stuck to their policy and the SGD has appreciated by at least 4% in the past 6 months, equivalent to a 8% annual rate of appreciation.
SGD Nominal Effective Exchange Rate (S$NEER)
See how the S$NEER line rockets upwards from January 2022 in the chart above? the SGD is strengthening like a bull enraged! So we should be having negative interest rates and negative inflation, right? After all, the exchange rate policy was formulated back in the day by Dr Goh Keng Swee to do precisely that.
What has caught central banks and policy makers in Singapore and elsewhere off-guard is how different countries have reacted to higher inflation and interest rates. So while the SGD has strengthened considerably in the past 6 months, it has done so only against a subset of currencies such as the Euro (EUR) and Japanese Yen (JPY):
On the other hand, the SGD has weakened significantly against the USD. Hence the strengthening of the S$NEER doesn’t mean that the SGD is stronger overall.
What does all this exchange rate mumbo-jumbo mean for the man in the street? Or rather, the home buyer needing to get a mortgage? What it means is that, because of the different ways different countries have approached the fight against inflation and raising interest rates (e.g. Japan wants to see inflation after years of deflation, so they are happy to let the yen depreciate and inflation rise), the strengthening of the SGD NEER doesn’t mean that we are keeping interest rates or inflation low.
In fact, by weakening the SGD against the USD (whether intentional or not), Singapore will continue to see interest rates matching or even higher than those in the US. This is the reason why the mortgage rates in Singapore have climbed so fast. This is unlike the last 2 US interest rate tightening cycles in 2015 and 2019. And this is also why inflation has continued to climb in Singapore, despite an exchange rate policy designed to counter it, because the key drivers of inflation now, energy prices and food (like wheat) are all traded in USD!
What now for mortgage rates? Higher, or lower?
So, what now for mortgage rates? Are they continuing to go higher, or will they stay at this level and fall? There are a couple of things to look out for:
- Will the SGD strengthen or weaken against the USD?
- Will the interest rates in the US continue to rise?
Will the SGD strengthen or weaken against the USD?
As mentioned, the current interest rate woes in Singapore have ben due to the SGD weakening against the USD, instead of strengthening, contrary to what the S$NEER shows. However, there was a brief rally in the SGD against the USD in late May/early June before the latest rate hikes in the US, so there is hope that in the near future, the SGD will reverse direction and start strengthening. If this happens, SGD interest rates may stop rising, and hence fixed mortgage rates will stay where they are, while floating rates will continue to track the US Fed Funds, albeit at a slower pace.
Will the interest rates in the US continue to rise?
One sliver lining on the horizon is that, while the Fed Funds rates will still continue to rise in the near term to 2.75% or 3.25% as the case may be, the market actually is starting to think that a recession might occur in the US before the end of the tightening cycle. And this will force the Federal Reserve to stop raising rates, or even to start cutting them. If so, this will match the pattern of previous tightening cycles, ending with swift interest rate cuts.
How do we know the mind of the market? One way is to look at how government bond rates are faring. The two year bond rates have gone up past 3%, but have come down since the last US rate increase. Perhaps this indicates that the current tightening cycle will end in less than 2 years.
The 10 year government bonds show a similar pattern, again indicating that the rate tightening cycle will be short. Short, relatively, meaning that rates will still continue going up for a while.
Overall, fixed rate mortgage rates may stay at the current levels of 3% for a while. Floating rate mortgage rates will continue moving upwards until the underlying rate hits 2% or more, meaning that borrowers will end up paying 2.5% or more at some point.
But if the pundits are right, this bout of higher mortgage rates will last for about a year or two!
The sharp rise in mortgage rates recently been surprising, not so much the level, but the speed. It appears that Singapore’s choice of tool to fight inflation, by strengthening the SGD exchange rate, may not be working well this time because of the sources of inflation are goods with USD prices, which is the currency the SGD has been weakening against instead. On the other hand, goods produced in Japan and Europe are cheaper, but they do not contribute much to inflation.
But rethinking how we fight inflation is a matter for brighter minds. In the meantime, we can expect that fixed rate mortgages will stay where they are for a while, while floating rate mortgages continue to rise in tandem with the rate increases in the US.