Singapore-US swap rates set to narrow on policy easing wagers

The gap between Singapore and US dollar interest-rate swaps is expected to narrow from near the widest level on record as monetary easing bets grow.

The city state's two-year overnight indexed swap rates are trading around 160 basis points below those in the US, with the gap between them near the widest on record in data going back to 2020.

The spread is expected to narrow as further policy easing in Singapore puts a floor under the nation's interest-rate swaps while those in the US fall as the Federal Reserve loosens policy. That dynamic benefits trades that receive fixed-rate payments in the greenback while paying in Singapore dollars.

"My baseline view is still for the spread to eventually narrow, as Singapore dollar rates have run ahead of a Federal Reserve rate cut," said Winson Phoon, head of fixed-income research at Maybank Securities Pte. "As such, when the Fed does indeed cut rates later, dollar rates could decline more relative to Singapore dollar rates."

Unlike most central banks, the Monetary Authority of Singapore uses the exchange rate - not interest rates - as its main policy tool. When the Singapore dollar weakens, this in turn puts upward pressure on interest rates as traders demand higher returns for investing in a weaker currency - a theory that is otherwise known as "interest rate parity."

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MAS has eased policy at two straight decisions in January and in April via a slight reduction in the slope of the policy band. Core inflation rose 0.5% from a year earlier in March, the slowest pace in four years, opening up room for further policy easing from the central bank, especially in the backdrop of a global trade war.

Policy easing so far hasn't pushed up local rates amid a resilient Singapore dollar and robust onshore liquidity due to slower bank lending, coupled with foreign inflows into fixed deposits. But that may change going forward, according to Frances Cheung, head of FX and rates strategy at Oversea-Chinese Banking Corp.

"As and when the market stabilises, further MAS easing if it comes may exert some upward pressure on short-end SGD interest rates, limiting the downside to these rates," Cheung said. "Chasing the two-year Singapore dollar rate lower is not preferred at this juncture," as it's already at the lowest level on the Singapore Overnight Rate Average curve.

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A drop in US rates on Fed policy easing wagers is unlikely to drive Singapore rates down meaningfully, which would further support the case for a narrower rate spread between the two nations if this trend persists. The pass-through from US rates to Singapore has fallen to minus 3.49, with two-year rate in the city down 60 basis points since late September while those in the US rose 17 basis points during the same period.

Table below shows a decline in pass-through rates since last year: