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How Does the Fed Not Cutting Interest Rates Impact Your Financial Lives?

Good if you are lending. Bad if you are borrowing.

The U.S. Federal Reserve (Fed) consistently garners attention in financial markets, and for good reason. Since March 2022, the central bank has raised interest rates from nearly 0% to a range of 5.25-5.50%.

This translates to an increase of the Fed’s base rate, known as the Fed Funds rate, by 500 basis points (bps), or 5%, in less than 18 months.

Anyone involved in global financial markets should be aware that the Fed’s monetary policy impacts the interest rate policies of every country. This influence is primarily due to the U.S. Dollar’s status as the world’s reserve currency. Commodities such as oil and wheat are traded in dollars, and approximately 60% of the world’s central bank reserves are held in U.S. Dollars.

Recently, there has been speculation that the Fed may cut its interest rates in 2024 as the U.S. economy shows signs of slowing. However, inflation remains persistent, and the anticipated interest rate cuts by mid-2024 have not materialized. Instead, many commentators now predict that the Fed won’t cut interest rates until sometime in 2025.

But for the average person, how does the Fed not cutting interest rates affect their financial lives?

Mortgages & Loans

Once the Federal Reserve began raising interest rates in 2022, mortgages with variable rates, known as “floating rate” loans, experienced higher interest costs. These loans had their interest repayment rates adjusted upwards.

For individuals already struggling with their mortgage payments under the original terms, this increase in interest rates can significantly impact their household’s cash flow. Similarly, new mortgage loans were also affected, with higher interest rates for borrowers.

Currently, floating-rate mortgages in Singapore can be as high as 4.5%, a stark contrast to the pandemic years of 2020-2021, when the Fed Funds rate was near zero and floating mortgage rates in Singapore were close to 1%. Consequently, deciding between a fixed mortgage or a floating mortgage rate has become much more crucial compared to the period between 2009 and 2020, when interest rates remained consistently low.

Mortgage rates are influenced by the “risk-free rate,” which in Singapore is the Singapore Overnight Rate Average (SORA), a benchmark overnight interbank SGD rate.

As expected, the SORA rate moved in tandem with the Fed Funds rate when the Fed began its rate hikes. Hong Kong, which uses the Hong Kong Interbank Overnight Rate (HIBOR), experienced a similar increase in its rate.

As a result, mortgage loans and loan rates are expected to remain elevated until the U.S. Federal Reserve starts reducing interest rates.

Sources: Phillip Capital, Bloomberg, PSR

Investments And Cash Savings

 Another area significantly impacted by the Fed’s monetary policy is your investments, including your cash savings.

This is primarily because the “risk-free” rate is now higher, meaning you can earn money simply by holding cash.

After the Global Financial Crisis of 2008-2009, interest rates remained close to zero for an extended period. This environment provided little to no return for savers on their cash. As a result, the phrase “There Is No Alternative” (TINA) to the stock market emerged, signifying that investing in stocks was perceived as the only way to achieve a return on capital.

However, this dynamic has shifted with the rise in interest rates. Now, high-interest-yielding savings accounts are available.

In Singapore, for example, certain banks offer up to 4% interest (and even higher in some cases) on cash savings. This increased rate of “safe investments” is also evident in instruments like Singapore T-bills and Singapore Savings Bonds (SSBs), both of which now provide substantially higher yields than before the Fed began raising rates.

For instance, the latest 6-month Singapore T-bill issue had a cut-off yield of 3.76%, compared to being less than 1% in 2021. This shift highlights how the Fed’s interest rate policies can enhance the returns on safer investment options, making them more attractive than riskier assets like stocks.

Looking To A Fed Rate Cut?

While the Fed’s decision not to cut interest rates has increased stress in the mortgage loan market, it has also allowed us to achieve better returns on our cash savings.

This is most evident in “cash-like” instruments such as T-bills and Singapore Savings Bonds (SSBs). Money market funds in Singapore Dollars and US Dollars have also provided investors with higher yields.

Looking to the future, the Fed’s eventual decision to cut interest rates will impact all of us. The ideal scenario would involve the Fed cutting rates amid a slowing economy, without significant job losses or a recession—a situation often called a “soft landing.” However, history has shown that the Fed typically cuts interest rates when a recession looms.

Regardless of the scenario, individuals should be prepared for potential easing in mortgage rates and lower savings returns when the Fed starts cutting interest rates.

Read Also: Why Is Japan’s Interest Rate Historically Low, And Why It Might Be Rising In 2024