What the Negative Swap Rate Means For You

August 25, 2011

In a surprising development, the Singapore dollar Swap Offer Rate (SOR) turned negative for the first time on August 10th due to inflows into the Singapore dollar. In this article we’ll explore what the SOR is, why it turned negative, and what impact that has on the banks, borrowers and depositors.

SOR is the effective cost of borrowing SGD synthetically through borrowing USD for 3 months and swapping out the USD in return for SGD for the same maturity.

The other commonly used benchmark is SIBOR (Singapore Interbank Offered Rate), which is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Singapore wholesale money market (or interbank market).

The Association of Banks in Singapore is the fixing authority for both rates.

Some of the differences between the two:

1. SIBOR is determined by the demand and supply of funds in the Singapore interbank market, whereas SOR is more influenced by external factors such as USD interest and exchange rates.

2. SOR tends to be more volatile because exchange rates and USD money market rates are more volatile.

Why did it turn negative?

Singapore has been attracting large inflows of U.S. dollars from investors looking for a refuge from the turmoil in the global markets. It also reflects market expectations of the exchange rate. In its April statement, the central bank MAS had effectively signaled its intention to allow the Singapore dollar to appreciate against a basket of currencies by re-centering the currency’s band upwards, thus exacerbating inflows from investors looking for a strong currency.

What is the impact for borrowers and depositors?

The negative SOR rate complicates the MAS’ efforts to clamp down on inflation. It may cause the MAS to rethink its policy on allowing the Singapore dollar to appreciate quickly to curb inflation – so far this year it has gained 6.5 percent versus the U.S. dollar.

But the expectation of a rapid appreciation will attract even more inflows from investors looking for a safe-haven currency in AAA-rated Singapore. With exports under pressure, there are also some arguing that the pace of appreciation should be slowed down.

For banks, the low interest rates have been hurting them by compressing their already low margins. As SOR has strayed into negative territory while interbank rates have stayed positive, some argue that it has started to lose its usefulness as a benchmark for pricing various loans such as mortgages. Some banks have now started to abandon SOR as a peg and switched to SIBOR or board rates. Some banks have also invoked “market disruption clauses” in their loan agreements to reset or use another benchmark for their loans.

Interest rates are likely to stay low for an extended period as the U.S. Federal Reserve has signaled its intention to keep U.S. interest rates low till the middle of 2013. For borrowers, this means your borrowing costs are likely to stay low in the medium term. As for depositors, it means you will get almost no return by keeping your money as deposits in the bank.

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by Propwise.sg on August 25, 2011 · 10 comments

Source: www.propwise.sg

Category: Forex

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