What is “Tapering” and how it is relevant to Singaporeans

How the Fed’s tapering will affect us in Singapore. 

You might have read or heard about this particular word, “tapering”, that has been occurring over the passed few months. Well, it is in relation to the US Federal Reserve’s (Fed) method of affecting interest rates. You may not really understand what it means, but we will explain today in details what it is and how it will affect you and I.
According to Oxford dictionary, the exact definition of taper is:

(Verb) “Diminish or reduce in thickness towards one end”.
Do not be frighten by the glut of ostentatious words that economist and finance-savvy people frequently use. It simply means that the US central bank (similar to the Monetary Authority of Singapore) has decided to reduce their monthly purchase of US government bonds, with an underlying assumption that the US economy is heading for a recovery.

With this reduction in demand for US government bonds, less is circulated into the economy, money becomes more “precious” and banks will charge a higher interest rate for borrowing it. Any Economics 101 module will cover this basic concept.

So how does this reduction in money supply affect Singaporean interest rate?

Singapore is always affected by the performance of her trading partners, namely ASEAN countries, China and the US. Therefore, in order to remain competitive, our “not-so-overt” monetary policy is used to reduce the fluctuation in the appreciation and depreciation of our currency against our main trading partners. Imagine if the SGD were to appreciate greatly against the USD. The US companies will reduce trading with Singapore, as it is now more “expensive” to buy Singapore goods or services thus affecting our exports. Hence, MAS and other relevant authorities will monitor a basket of currencies and aim to keep the SGD competitive to ensure stability of trade.

With expectations of a rising interest rate environment in the US, we should also expect Singapore to follow suit in its own monetary policies, which would ultimately increase our local interest rates.
How will this affect us?

Most Singaporeans would have already, or will eventually, embarked on the largest investment in our life, our homes. Purchasing your 1^st HDB flat will expose you to the risk of interest rate rising.

The extent of how much interest rate will affect you depends on whether you have obtained an HDB loan, at concessionary interest rate, or a bank loan, which is likely to be pegged to market interest rate.

For those who have obtained the HDB loan, rising interest rate will not have a huge bearing on your interest rate and mortgage repayments, as it is currently capped at 0.1% above the prevailing CPF interest rates. Therefore, the factor governing your interest payment is not directly dependable on the market interest rates but rather the CPF interest rates. This is not to say that you are safe from any interest rate movement, as it is definitely possible for CPF interest rate or policy can still be changed.

A bank loan would typically be dependent on a floating market rate, also known as the Singapore Inter-Bank Offer Rate (SIBOR). Let us use an illustration to see how it a rising interest rate will affect us.
 

Illustration:

You borrow $250,000 from DBS at a fixed interest rate of 1.5% for the first three years, after which it will shift to a 1.1% + 3 month SIBOR for the remaining 22 years of your 25 year loan period.

Monthly payment and interest rate sensitivity table

The current 3-month SIBOR rate is 0.40267%. Therefore, if you are passed the 3 year fixed rate, you will be paying 1.50267% annually, similar to the fixed rate of 1.5%, of about $1000 monthly.

However, if SIBOR were to increase to 1%, the same quantum of loan would require you to pay 2%. This would meant a rise of $60 monthly, $720 annually and additional of $15840 over 22 years.

We are looking at a rising interest rate; hence, the 3-month SIBOR will not stop at a rise of only 0.5% but a gradual increase thereafter. Just a 0.5% increase would make one pay an additional $15840 over the loan period, if interest rates were to further increase, it will be a blow to one’s immediate cash flow as well as long term liquidity.

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