Swap offered rate turns negative for the first time

Singapore has safe haven status, which has pushed up the currency and pushed down domestic interest rates in recent weeks, with swap offered rates even turning negative. While the decline in interest rates could spur credit demand, it's likely to be minimal. Also, macro prudential measures could be rolled out to tighten things up, if needed. Importantly, considering the dark clouds hanging over the global economy, there is more reason to be concerned about a potential economic slowdown in Singapore's high-beta economy.

Facts
Singapore has status as a safe haven destination in the region given its sound macro economic foundations, as reflected in a AAA sovereign rating, and relatively deep as well as liquid markets.

In conjunction with the discouraging economic data being released recently and the debt sagas playing out in Europe and the US, uncertainty and market volatility has flared up and has, consequently, seen investor flows heading towards perceived safer harbors such as Singapore. In turn, this has putt upward pressures on the Singapore dollar. The Fed's commitment to keep policy rates at exceptionally low levels until mid-2013 re-enforced these flows.

Many of the safe haven flows to Singapore are ending up in short-term cash deposits, which has been evident from the forward markets. For example, the swap offered rate (SOR)--a derived rate for borrowing SGD in the forward market through a foreign exchange swap transaction--turned negative for the first time in its history on August 10 and remains in negative territory for certain maturities. This also reflected market expectations of further exchange rate appreciation, which reduces the interest rate at which investors are willing to hold the Singapore dollar.

Implications
Singapore faces the text book trilemma of an economy with an open capital account. Having already chosen the exchange as the monetary policy instrument to target inflation, the MAS cannot at the same time control domestic interest rates which are market determined and heavily influenced by global liquidity conditions. With monetary policy settings in the advanced economies remaining very loose, this has left Singapore's domestic interest rates very low.

This can, of course, complicate policy making to the extent capital inflows create excess domestic liquidity, potentially boosting credit growth and inflating asset prices. Now, the recent safe haven flows and negative interest rates have caused concerns among Singapore observers that monetary policy has now become more complicated as inflation remains elevated and house prices are still trekking up. Also, the concern partly relates to the fact that some commercial loans and mortgages are linked to the now negative SOR.

How concerned should one be about the macroeconomic implications of this recent development in the SOR market? The short answer is that there is no reason to be overly concerned. First, the majority of mortgages and commercial loans are not linked to the SOR but rather to the SIBOR, and we may actually see more loans pegged to the SIBOR in the future, partly in light of the recent market disruptions. Second, a great deal of the loans linked to the SOR (plus a premium) have a clause, which limits the benchmark drop to zero or allows a renegotiation or a peg to the cost of funds. Finally, if needed, further macro prudential could be rolled out to tighten financial conditions.

Moreover, the MAS does not seem overly panicky about this either. In fact, the MAS send out a statement last week saying there had not been any need to undertake extraordinary measures in response to this and it also confirmed that the current monetary policy stance remains appropriate.

Importantly, the big picture here is that the safe haven flows and the negative rates reflect rising concerns about the global economic outlook. To the extent the global economic cycle softens further in the months ahead, which seems increasingly likely, this would clearly have implications for Singapore's high-beta economy and this is probably more so on the MAS's radar screen rather than the implications of these shorter term safe haven related interest rate movements.

Bottom line: Singapore's success has given it status as a safe haven destination, which has pushed up the exchange rate during the recent bout of financial market volatility and has even led to negative interest rates in certain segments of the market. The negative SORs are, however, not expected in themselves to have significant macroeconomic implications. Also, the big picture here is how strongly the global economic headwinds are going to blow and their impact Singapore's high-beta economy.