Introduction

The Monetary Authority of Singapore (MAS) was one of the earliest central banks to tighten monetary policy as inflation accelerated in 2021. Meanwhile the Hong Kong dollar peg to the US dollar meant the Hong Kong Monetary Authority’s (HKMA) Base Rate increased in lockstep with the Federal Reserve’s (Fed) target rate since the US started hiking rates in early 2022. However, despite these aggressive central bank actions, short tenor Singapore and Hong Kong yields remain substantially lower than their US Secured Overnight Financing Rate (SOFR) equivalents – with significant implications for HK$ and SG$ cash investors.

Excess liquidity

Both Hong Kong and Singapore have recorded large liquidity inflows over the past few years. In Hong Kong, a combination of weaker confidence in Hong Kong assets and desire of Chinese investors to diversify to higher yielding USD assets has pushed the Hong Kong monetary base sharply higher – despite the Hong Kong Monetary Authority (HKMA) reducing the Aggregate Balance. Meanwhile Singapore’s status as a safe haven combined with a stable currency and outflows from China have triggered significant liquidity inflows. This has been turbo-charged recently by regional investors who want to reduce USD exposure. The Monetary Authority of Singapore has attempted to partially sterilize these inflows via Treasury Bill issuance – which has doubled in the past 3-years to SG$410bn.

Market impact

Short term Singapore and Hong Kong interest rates have risen sharply from record lows in 2021. While yield curves have flattened as investors anticipate that the Federal Reserve and APAC central bank base rates have peaked, short term interest rates remain very close to record highs.

Historically Singapore and especially Hong Kong interest rates have observed a high correlation with US monetary policy. The smaller local market and APAC risk premium suggest Singapore and Hong Kong rates should trade at a premium to US SOFR, but during the current interest rate cycle they have significantly lagged the upward trend in US SOFR rates while being more volatile. Significant liquidity inflows into both currencies are the primary reason for this spread differential.

Implications for investors

We believe the MAS will retain its hawkish monetary policy (with the SG$ nominal effective exchange rate appreciation by approximately 1.5% per annum) while Hong Kong will retain its US$ peg. However, until Asian investor confidence improves and local liquidity conditions normalize, interest rates in both cities are likely to remain volatile – especially as the Federal Reserve attempts to pivot to a more dovish policy stance against a background of erratic and unpredictable data dependence. Nevertheless, for SG$ and HK$ cash investors – they should continue to enjoy multi-year high yields for the foreseeable future.