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If the Fed looks through the rise in prices, the real exchange rate will appreciate. The increased inflation due to tighter labor markets would also tend to increase the real exchange rate, though this almost certainly would not be accommodated by the Fed. We conclude that the Fed’s response to the introduction of border adjustments—under the crucial assumption of no change in the exchange rate— implies a path for the funds rate at least 3.5%-points higher than the baseline, simply because of their response to pressures on resource utilization. Any additional response to import price pass-through would imply even more tightening than that.
Pay 1Y2Y SGD IRS and receive 1Y2Y USD IRS Pay 1Y2Y SGD IRS and receive 1Y2Y USD IRS at a spread of +12bp, with a target of +42bp and a stop loss at -3bp. The roll down is -0.5bp per month and the time horizon is 2-3 months. The forward rate spread curves are steeper for the 1Y and 2Y rates than for longer tenors, while we would like to avoid tenors below 1Y as flush SGD liquidity and/or USD funding needs are factors that can continue to cap front-end SGD rates.
Risk profile: Liquidity; Fed Continued flush SGD liquidity (can be facilitated by b/s USD/SGD flows arising in turn from central bank operations or investor funding needs) will suppress SGD rates.
A week that delivered hawkish Fed testimony, and a solid set of upside data surprises failed to deliver a stronger dollar. This inability to sustain a rally despite a perfect overlap of hawkish fed and bullish data this week, suggests we might need something more phenomenal for the USD to materially retrace back to January highs, much less a break of new highs.
So, if the Fed turns more dovish, the FX impact on SGD rates may not kick in. High negative correlation between 1Y2Y SGD-USD IRS spread and 10Y UST yield – but this precisely reflects the period when SGD rates were resilient amid the uptrend in USD rates which is unlikely to continue in our view.
