Hong Kong Hibor and Singaporean SOR interest rates have climbed in tandem with US Libor over the past few years – but their upward trajectory has not always been steady (Fig 1a) and they have frequently lagged Libor. Recently, more dovish Fed comments have triggered a decline in US Libor – however, influenced by domestic factors the ascension of Hibor and SOR has actually increased (Fig 1b) – with positive implications for local currency cash investors.
Singapore MAS: Looser monetary policy implies higher rates
Consistent with other central banks, the Monetary Authority of Singapore’s primary policy objective is price stability. However its monetary policy is unusual in that it focused on managing the exchange rate (via the SGD nominal effective exchange rate – S$NEER) rather than interest rates (Fig 2a). Given this focus, the four Federal Reserve target rate hikes in 2018 exerted significant upward influence on SOR yields which recently hit a decade high.
Historically, expectations of a stronger SGD propel the S$NEER above the mid-point of its trading band, which, consequently exerts downward pressure on local interest rates (Fig 2b). Since 2015, core inflation has gradually moved towards the MAS’s target range, allowing the central bank to assume a more hawkish policy stance. This culminated in two S$NEER slope increases (approximately +0.5%) at both its April and October 2018 monetary policy meetings, which curtailed the upward momentum of SOR yields.
Recent domestic economic activity has been weaker than the MAS’s forecast with slower growth, exports and private consumption. Meanwhile, the fall in oil prices and sluggish wage growth have muted core inflation – restricting the central bank’s hawkish mandate.
At its upcoming monetary policy meeting in April, the MAS is likely to leave the S$NEER slope unchanged while assuming a more neutral policy stance. This will negatively impact expectations of future SGD appreciation, push the S$NEER lower and place upward pressure on SOR yields.
Hong Kong: Escaping the liquidity trap
Unusually, Hong Kong does not pursue an independent monetary policy, rather it maintains HKD currency stability within the framework of the Linked Exchange Rate System (LERS). This is guaranteed by ensuring the HKD monetary base is fully backed by USD reserves held in the exchange fund at a fixed exchange rate of HK$7.80 to US$1 (Fig 3a).
Therefore, the four Federal Reserve target rate hikes in 2018 also exerted significant upward influence on Hibor yields, which recently hit a decade high. Linked exchange rate theory suggests that Hibor should be higher (or lower) than Libor when the HKD is trading at the weak (or strong) side of convertibility. Yet, despite the HKD trading on the weak side of convertibility (between HK$7.80 to HK$7.85) for the past two years, Hibor yields remain stubbornly lower than their Libor equivalents.
The main culprit is Hong Kong’s monetary base, which has tripled in size over the past decade as liquidity, mainly from China, flooded Hong Kong’s banking system.
In the past several weeks, liquidity outflows combined with the arbitrage opportunity triggered by the wide Hibor/Libor spread caused the HKD to repeatedly hit the weak side of convertibility at HK$7.85 (Fig 3a) versus the US$1. This forced the Hong Kong Monetary Authority (HKMA) to intervene in the forex markets on five occasions, purchasing a total of HK$11.586bn (US$1,746bn) to defend the peg. This represents the fourth in a series of FX interventions (Fig 3b) over the past year and has reduce the aggregate balance to an 11-year low of HK$64.7bn.
Following the HKMA actions, Hibor rates increased and the spread versus Libor contracted. Yet, the HKD remains very close to the weak side of convertibility – suggesting further HKMA intervention and additional upward pressure on Hibor.
Conclusion: The dovish paradox
For Singapore and Hong Kong cash investors the recent higher SOR and Hibor yields are welcome following an extended period of low returns and negative real yields. As the positive momentum triggered by previous Federal Reserve rate hikes fades, domestic factors are assuming increasing importance and paradoxically pushing local interest rates higher –closing the gap with US Libor and providing additional benefits to investors.