The Fed Finally Cut Rates : What Does This Mean for Singaporean Investors

On September 18, 2024, the U.S. Federal Reserve made a significant move by cutting interest rates by 0.5% or 50 basis points, bringing the target range to between 4.75% and 5%. This marked the first reduction in borrowing costs since 2020.

For investors in Singapore, it is extremely beneficial to understand the implications of this decision. The Fed's actions not only influence the US economy but also have far-reaching effects on global markets, including Singapore's financial landscape.

1. Understanding the Fed's Rate Cut Decision

Reasons behind the rate cut

The Fed's decision to lower rates is part of a broader recalibration of its policy. Over the past year, it had maintained a restrictive stance to tackle high inflation and protect purchasing power, especially for essentials like food and housing.

Now that inflationary pressures have eased, the risks to employment have grown. By lowering interest rates, the Fed aims to support continued economic growth without jeopardising the progress made on inflation.

Fed Chair Jerome Powell elaborated on this shift during a press conference on September 18, stating:

“The labour market has cooled from its formerly overheated state. Inflation has eased substantially from a peak of 7 percent to an estimated 2.2 percent as of August. We’re committed to maintaining our economy’s strength by supporting maximum employment and returning inflation to our 2 percent goal”

Historical Context of Fed rate cuts

Historically, significant rate cuts have been employed during economic downturns or crises. For instance, during the 2008 financial crisis, aggressive rate cuts were implemented to stimulate economic activity.

In comparison, today's cut is seen as a proactive measure rather than a reaction to an immediate crisis, indicating a shift in policy focus towards sustaining growth.

2. Direct Impacts on Singapore's Economy

Singapore dollar's value

Following the Fed's rate cut, fluctuations in the Singapore dollar (SGD) are likely:

• Potential Appreciation: A lower interest rate environment in the US may lead to a weaker USD against other currencies, including SGD.
• Implications for Trade: As Singapore is heavily reliant on exports, any appreciation of SGD makes US imports cheaper and lowers Singapore’s export competitiveness.

Interest rates in Singapore

Local interest rates typically follow trends set by the Fed:

• Expected Declines: With the Fed's cut, local banks may lower their interest rates for loans and deposits. For example, fixed-rate home loans have already seen average rates drop from around 3% to approximately 2.6%.
• Effects on Borrowing Costs: Lower interest rates can ease financial burdens for homeowners and businesses alike, stimulating spending and investment.

3. Opportunities for Singapore Investors

Real estate market

The property market may experience notable changes:

• Increased Buyer Interest: Lower mortgage rates can enhance affordability for homebuyers, potentially leading to increased transactions in both residential and commercial properties.
• Investment Considerations: Investors should assess market conditions carefully; while lower rates can stimulate demand, they should also be wary of potential price surges that could lead to an overheated market.

Bond market effects

The bond market will also reflect these changes:

• Declining Yields for newly issued bonds: As interest rates fall, bond yields are expected to decrease, making existing bonds more attractive. As newly issued bonds offer lower yields, existing bonds with higher yields become more attractive. Investors are willing to pay more for these existing bonds, driving their prices up.
• Strategies for Bond Investors: Consider shifting towards shorter-duration bonds or diversifying into higher-yielding alternatives as yields decline.

4. Risks and Challenges

Currency risk for international investments

Investors with exposure to USD-denominated assets must manage currency risks:

In light of global conflicts such as the Russia-Ukraine war and Israel-Hezbollah/Hamas tensions, investors holding USD-denominated assets must be mindful of managing currency risks. These geopolitical events cause market volatility, not only affecting asset prices but also influencing currency movements.

As the US dollar is often seen as a safe-haven currency, during times of heightened global uncertainty, the dollar may strengthen as investors seek safety in USD assets. While this can benefit USD-denominated holdings, the strengthening of the USD can also impact global trade and reduce the competitiveness of US exports, affecting the performance of US companies, particularly those with international exposure.

For Singaporean investors, these USD/SGD exchange rate fluctuations can impact returns when converting USD assets back to Singapore dollars. For instance, if the USD strengthens significantly, it could enhance returns for Singaporeans holding USD-denominated assets. A reversal in this trend, particularly if the Federal Reserve cuts interest rates or global tensions ease, could weaken the USD and lower the SGD-converted value of these investments.

To manage these currency risks, investors may consider hedging strategies, such as using currency forwards or options or diversifying their portfolios across multiple currencies and asset classes. Monitoring the geopolitical landscape, along with the USD/SGD pair, is crucial to making informed decisions on when to invest in or exit USD-denominated positions to maximise returns and minimise currency-related losses.

Potential market volatility

Market reactions can be unpredictable:

• Short-term Volatility: Initial responses may include sharp fluctuations in stock prices as investors adjust their expectations based on new monetary policy signals. For instance, following the Federal Reserve's 50-basis point rate cut on September 18, 2024, major U.S. stocks, including tech giants like Apple, Tesla, Nvidia, and Amazon, saw significant price increases. These companies benefit from lower borrowing costs and heightened investor interest in high-growth sectors like technology and AI.

Examples As of September 18, 2024, right before the Fed's rate cut announcement, the stock prices were: Nvidia: Approximately $430. Following the cut, it surged to about $470 (+9.3%) within 48 hours before profit-taking began. Tesla: Around $260, increasing to about $277 (+6.5%) over three days. Apple: Roughly $180, climbing to $187.4 (+4.1%) in two days before retracing due to market adjustments. The bull run for these stocks lasted 2-3 days, driven by optimism post-announcement.

• Long-term Considerations: A focus on fundamentals rather than short-term noise can help investors navigate through volatility effectively.

5. Investment Strategies for Singaporeans

Sector-specific opportunities

Identifying sectors that typically benefit from lower interest rates can yield positive results:

Focus on Rate-Sensitive Assets

Lower interest rates typically benefit sectors such as:

Real Estate Investment Trusts (REITs): In Singapore, before the Fed's rate cut on September 18, 2024, Singapore REITs (S-REITs) were yielding in the range of 4.5% to 5.5%.

After the announced rate cut**,** the average yield for S-REITs is around 5-6%, making them attractive for income-seeking investors, thus enhancing their profitability. The rate cut has eased these pressures, pushing the average yield up to 5-6%, making S-REITs more profitable by improving cash flow through lower debt servicing costs. This will be reflected in the increase in the acquisition activity of new properties, driving potential rental income.

Be sure to check out our Be REITired series to learn how Singaporean REITs could be your ticket to a comfortable retirement.

Utilities: Companies in this sector often have stable cash flows and can finance infrastructure projects more cheaply, ensuring steady dividends. You can look at firms with average stock price increase that are poised to benefit from these conditions:

• Vistra Corp. :- Up about 141% year-to-date. Known for its aggressive expansion in renewable energy, it has performed well, particularly with its renewable initiatives in wind and solar power.
• NRG Energy Inc. : - Up about 112%. year-to-date. NRG is another strong performer, driven by its focus on transitioning to cleaner energy while maintaining robust dividend payouts.
• Constellation Energy Corp.: - Up about 70%. year-to-date. Constellation has benefited from increased energy demand and its strong position in both nuclear and renewable power generation.

Consumer Discretionary and Technology: Lower rates make it easier for consumers to finance big-ticket purchases, boosting sales for companies in these sectors. Tech firms can also invest more in growth initiatives due to cheaper capital.

So far, companies like Nvidia and Tesla have led this rally with significant stock price increases as a result of seeing increased demand as consumer spending rises.

Small-Cap Stocks

Small-cap stocks typically thrive in low-rate environments due to their reliance on borrowing for growth. The Russell 2000 index, which includes smaller companies, has shown promising performance post-rate cut, rising by 2.1% recently.

Look for opportunities among small-cap firms listed on Singapore's Catalist board, particularly those in technology and healthcare sectors that could leverage lower borrowing costs.

Fixed Income Investments

With cash yields expected to decline, consider reallocating funds from money market accounts into longer-term bonds or dividend-paying equities. Historically, bonds have performed well following Fed rate cuts due to capital appreciation (bond price increase) from falling yields.

Focus on intermediate-term bonds rather than long-duration ones to mitigate risks associated with potential government spending increases. It’s because long-term bonds are more sensitive to changes in interest rates. If the government increases spending, it might lead to higher interest rates, which can significantly lower the prices of long-term bonds.

Conclusion

The recent Fed rate cut marks a pivotal moment for investors in Singapore. Understanding its implications—from potential currency fluctuations to opportunities across various asset classes—is essential for making informed decisions.

The key takeaway is clear: staying proactive will serve you well in these uncertain times.