The Crystal Ball of Mortgage Interest Rates: Interpreting the Current Economic Landscape for the Future

For many home buyers, whether purchasing for personal use or investment, securing a housing loan is a significant factor in their decision-making process. When seeking a housing loan, there are various factors that affect how much loan you can get. This includes age, nationality, income etc. 

In this article, we will be talking about an important factor of mortgage loans which is interest rates. Interest rates not only determine whether you can afford your monthly loan repayments but also directly affects your Return on Investment (ROI). The higher the interest rate, the higher your cost of investment, which in turn reduces your ROI.

Stress Test Rates

In the realm of finance, a stress test involves planning for the worst-case scenario to ensure financial resilience, especially in the context of mortgage loans. It is not designed to make homebuyers have more difficulty getting a loan but rather making sure homebuyers do not get loans that are out of their capability.

To safeguard against potential misuse of unrealistically low stress test rates by banks to attract customers, the Monetary Authority of Singapore (MAS) has mandated a minimum stress test rate that all banks must adhere to and is currently at 4% for residential property loans.

Shown below are the stress test rates of the different banks.

Source: Loan Experts

To gain deeper insights into the current interest rate landscape, it’s valuable to examine the prevailing fixed versus floating mortgage rates.

Fixed v.s. Floating Rates

Source: Loan Experts

The current landscape of mortgage interest rates as of November 2023 reveals a notable phenomenon: the floating interest rate stands at 4.35%, while the 2-year fixed interest rate, applicable for a minimum loan of $700k with a locked-in period of 2 years, is lower at 3.10%.

This deviation from the conventional pattern, where fixed rates are typically higher to compensate for the risk undertaken by banks, signals an intriguing shift. Normally, banks set fixed rates higher as a premium for offering stability during a specified period, given the uncertainty of interest rate fluctuations.

In this instance, the fixed rate being lower than the floating rate could imply that banks are anticipating a decline in interest rates. This decision suggests a strategic move by banks to align fixed rates more closely with their market predictions.

However, it’s essential to recognize that interest rates are lagging economic indicators. The leading indicator for interest rates is usually inflation rate. Inflation can prompt central banks to adjust interest rates, typically raising them to curb spending and mitigate the effects of high inflation.

However, before analysing the inflation rates, we have to first understand how MAS carry out its monetary policies to manage inflation.

MAS Monetary Policy

Central banks worldwide typically manage inflation through monetary policy tools like adjusting domestic interest rates (control loans) or controlling money supply (printing money). However, the MAS, as Singapore’s central bank, does not do any of that. Instead, MAS controls Singapore’s exchange rate.

This is due to Singapore’s status as a small and open economy, which means we do more trading with other countries rather than produce goods and services in our own country. For example, 90% of our food is imported from countries like China, Malaysia, Vietnam, Indonesia and even Brazil. Thus, all these transactions often involved various foreign currencies.

Since there are so many foreign currencies involved, in order to measure the exchange rate of Singapore, we cannot just measure against one particular currency. Thus, Singapore’s exchange rate is measured against a basket of various currencies and this is called the Singapore dollar nominal effective exchange rate (S$NEER). How much percentage of the foreign currency is in the basket are determined by the significance of their trade relationships with Singapore, making the S$NEER a trade-weighted exchange rate.

MAS does not fix an exact exchange rate of S$NEER but rather allows the exchange rate to fluctuate within a range. There are three factors that can affect this range that MAS can adjust in order to control inflation, namely Slope, Level, and Width.

Source: MAS

Imagine a scenario where the prices of foreign goods increase, which means the imports would also be more expensive in Singapore Dollar terms assuming that various exchange rates do not change. When goods and services increase in price, inflation rises.

In this situation, MAS will tighten their monetary policy, which means it supports a stronger S$NEER, the higher-priced imports will become cheaper in terms of Singapore Dollar for consumers and businesses. This has a direct impact on lowering inflation in Singapore.

A stronger S$NEER also means that imported goods are cheaper than locally produced goods. Thus, consumers will switch to purchasing foreign goods instead of domestic goods. Singapore goods will also be more expensive for foreign buyers, thus decreasing the sales and revenue of Singapore exporters. This has an indirect impact on lowering inflation in Singapore 

Nevertheless, the effect of MAS’s monetary policy on the economy is not immediate. This is due to the fact that businesses consider various factors beyond exchange rates when setting prices. Thus, inflation is also not immediately affected when MAS adjust the monetary policy.

How Does This Relate to Singapore’s Interest Rate?

Hence, as MAS doesn’t directly set interest rates in Singapore but manages the exchange rate to combat inflation, Singapore’s interest rates closely follow the US interest rates established by the Federal Reserve. The US interest rates, in turn, are influenced by US inflation levels. Therefore, monitoring the US inflation rate becomes pivotal as a leading indicator for both US and subsequently Singapore’s interest rates.

Source: US Bureau of Labor Statistics

In the current scenario, the decline in core inflation in the US suggests that the Federal Government might not pursue further increases in interest rates and could even consider a decrease. This aligns with recent developments, such as the most recent Fed meeting, where the decision was made to maintain the interest rate unchanged.

Source: The Ascent – A Motley Fool Service

As we established before, Singapore’s interest rates are affected and closely related to US interest rates. With the Fed rate remaining unchanged, this suggests that Singapore’s interest rate would also most likely stay unchanged. 

Interest rates are still only one component of a housing loan and if you’re still unsure about your affordability and what kind of loan package to take, feel free to contact Loan Experts and we will be happy to assist you.

Do you know high interest rates are an indicator of a buyer’s market? Click here to find out more about the private residential property market outlook and why this is the case.