SINGAPORE (The Straits Times/ANN) - Fed's latest hike has downsides, but change was expected and local economy can weather it.
One of the world's most closely watched games of "Will they or won't they?" finally came to an end last week.
The United States Federal Reserve announced that it would raise a key interest rate for the first time this year after months of speculation among market watchers.
This was good news for the US because it signals a recovering economy, but the picture is more mixed for Asia and Singapore.
The US central bank raised its benchmark federal funds rate — the rate banks charge each other for overnight loans — on December 14 by a quarter of a percentage point, citing an improving economy and labour market.
The widely anticipated increase was just the second since the 2008 global financial crisis and is expected to ripple through the economy, nudging up rates on credit cards, mortgages, vehicle loans and bank savings accounts.
The Fed said it expects to raise rates three more times next year.
What do higher interest rates mean for Singapore and the region?
Interest Rates At Historic Lows
Since the global financial crisis, major central banks around the world have used ultra-low — even negative — interest rates as a tool to revive economic growth.
Lower interest rates make it cheaper and more appealing for households and businesses to borrow. They also incentivise banks and companies to lend or invest because parking money in the bank yields almost no returns.
The euro zone, Denmark, Sweden, Switzerland and Japan all now have negative interest rates.
Interest rates in the US were also slashed to ultra-low levels after the global financial crisis, though the Fed finally pulled the trigger last December and raised rates for the first time in almost a decade.
That first hike was a signal that the US central bank was confident about the strength of the economy and its ability to handle higher borrowing costs.
The Fed had expected to make four further increases this year, but a range of obstacles emerged, including China-spurred turmoil in financial markets and Britain's vote to leave the European Union, which threw a spanner in the works.
Still, its latest move — as well as the anticipated hikes next year — underscores a gradual upward trend in US economic activity.
Higher Borrowing Costs, Savers To Get a Boost
Higher US interest rates mean higher borrowing costs for households and companies here. These include rates on mortgages, credit cards and corporate loans, and also bank savings accounts, which will be a boon to savers.
The three-month Sibor, or Singapore interbank offered rate — used to price home loans — shot up in the wake of the US presidential election as well as after the Fed's rate hike announcement last week.
It is now at about 0.96 per cent, up 10 per cent from November 11 and the highest since June.
The Sibor is typically highly correlated with US interest rates.
"Both firms and households will see costs going higher," says UOB economist Francis Tan.
"Households will be affected mainly through mortgage loans, while firms will need more cash to repay their corporate borrowings. This will increase their business costs even further."
A quick check with banks here showed that fixed deposit rates and interest rates for fixed-rate mortgages are largely unchanged although some lenders said they are still in the process of determining rates for next year.
But UOB's forecast is for the three-month Sibor to inch up to 1.05 per cent by the second quarter of next year.
The timing of the US rate hike last week "is not good" for Singapore's slowing economy in the short term, says CIMB Private Bank economist Song Seng Wun.
Given already lacklustre business and consumer sentiment, higher interest rates could further dampen spending and weigh on companies' investment plans. The rate increase "coincides with a worsening in labour market conditions," Song notes, and comes at a time when wages are growing more slowly, retrenchments are up and there are fewer vacancies.
Capital Outflows, Weaker Currencies
Another concern for Singapore and the region is the prospect of investment funds flowing out.
Higher rates prompt investors to move money out of emerging markets into US dollar-denominated assets, putting pressure on Asian currencies and asset markets.
Something similar happened in 2013, when the Fed announced that it would wind down its policy of pumping money into the financial system through aggressive bond purchases. Many investors pulled money out of Asian economies, resulting in what has been called the "taper tantrum." Asian currencies weakened against the US dollar as a result.
There are worries that it will be worse this time. The Washington-based Institute of International Finance notes that foreign investors pulled $16 billion of portfolio capital out of Asian emerging markets last month compared with $20 billion in June 2013, during the taper tantrum.
Departing investors expect President-elect Donald Trump's plans to ramp up government spending to boost inflation in the US and push up interest rates further.
Asian currencies slid against the dollar in the wake of the Fed's latest rate hike. The ringgit has been among the worst hit, slumping on Monday to levels last seen in 1998, during the Asian financial crisis. It has since recovered slightly but is expected to remain weak against the surging greenback.
The US dollar has also surged to its highest level in seven years against the Singapore dollar, reaching 1.449 Singapore dollars on Monday.
The South Korean won, Philippine peso and Japanese yen — among others — have also dropped.
The greenback is expected to retain its strength against Asian currencies, including Singapore's, next year.
This means imports from the US will be pricier, UOB's Tan says, adding that the bank's forecast is for one US dollar to buy 1.48 Singapore dollars in the coming year.
Stronger US Growth a Boon?
The rate hike points to a stronger US economy, but economists are divided over whether this will significantly impact Singapore.
"Trump's campaign promises to 'make America great again' could lead to more fiscal spending, which could add to growth in 2017 and 2018," says Song. "We can take heart from the possibility that the stronger US economy will trickle down to us in terms of stronger growth and more exports of goods and services, especially in the longer run."
But Credit Suisse economist Michael Wan warns that Trump's policy priorities might not benefit growth in Singapore and the region.
The President-elect's campaign focused on bringing jobs and manufacturing back to the US. It is still unclear how this will translate into actual policies, but "I suspect it'll be a combination of some high-profile tariffs on specific sectors, using tax incentives to encourage US companies to increase their presence domestically relative to other countries, and perhaps also encouraging domestic hiring of workers," Wan notes.
This means the US may not import as much from the rest of the world even as its economy gains pace.
"As such, I doubt an improvement in US growth will benefit Asia and Singapore as much now as in the past. In other words, the negative impact from the rise in interest rates will likely more than offset expected benefit from stronger US growth," he adds.
Clearly, higher interest rates in the US have significant implications for Singapore in the coming year.
But when it comes to raising interest rates, it was never a question of if, but when.
The Fed has been under pressure to "normalise" rates for some time, and market watchers have accused the central bank of kicking the can down the road in holding off rate increases throughout this year.
This is because it is not clear whether eight years of ultra-low interest rates since the global financial crisis have helped lift economic growth.
Japan's economy, the pioneer of ultra-low interest rates, remains mired in lacklustre growth. The country implemented zero per cent interest rates almost 20 years ago and recently moved rates into negative territory.
Growth in the euro zone, meanwhile, is still almost flat and unemployment remains high.
Another reason why some economists have called for interest rates to go up is that ultra-low rates have created new risks for investors around the world.
Much of the criticism has focused on the dangers of asset bubbles. A persistent theme is that low rates are distorting asset prices by pushing investors to adopt excessively risky investment strategies in search of yield.
Ultra-low interest rates have also pushed up debt levels around the world. All major economies have higher levels of borrowing relative to the size of their economies than they did in 2007, according to a report last year by the McKinsey Global Institute.
This would not be an issue if the cost of paying down debt remains low. But when interest rates go up and access to credit becomes more difficult, debt payments can chip away at corporate profits and investment and weigh on economic growth.
Ultimately, persistently low interest rates are not healthy for the global economy, and it would have been both unwise and unrealistic to expect rates to remain at such low levels in perpetuity.
CIMB Private Bank's Song also points out that while interest rates are inching up, "they are still far from historically normal levels and are still very low."
The Monetary Authority of Singapore has implemented measures to ensure households are better equipped to deal with an uptick in rates, including moves to curb imprudent borrowing.
"This was anticipated, people knew it was coming. We will ride through it," he says.