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Musings On Singapore Dollar

The last few days I've been thinking a bit more about USD/SGD rates. I've started to increase my USD/SGD short (going long SGD), and am considering how much I want to put into this now, versus waiting 'to see what happens'.

Here are the factors in play (comments appreciated):

Interest rate parity-IRP: A few academic articles have shown that interest rate parity holds for SGD. While uncovered IRP does not hold for most currency pairs, SGD is different. MAS does not target interest rates, so SGD rates are set entirely by free market. Of course the main market is USD, so SGD rates generally work out to be USD + irp. This means that if SGD rates are above USD the market is expecting higher USD/SGD

Inflation: SG inflation > US inflation. Normally this would mean that SGD is weakening (through purchasing power parity). In this case I think that doesn't apply. SG's higher inflation is due to non-tradables (goods/services which can only consumed in singapore and not traded). Thus there is no arbitrage mechanism and therefore the fx rate is not obligated to adjust. Tradable goods are priced in USD anyway, so no arbitrage exits.

Swap Offer Rate: SOR has not adjusted down to account for a strong USD. Based on current USD SIBOR - SOR, the market is pricing forward fx rate at a moderate drop in USD/SGD.

US economy strengthening: SG economy has been killing US economy over the last 3 years. That spread is likely to narrow, which makes USD look better.

End of QE3: Honestly I don't think QE3 has any real impact other than depressing interest rates. If QE3 had real impact through increased USD supply then USD/SGD should have tanked to absurd levels. It didn't. I suspect supply here is irrelevant (the technical reason is that supply of fed funds increased with QE3, but few people want fed funds, most prefer bank deposits, and that supply did not change much with QE3).

However! QE does have big impact on perceived USD value/supply (remember everyone worrying about inflation?). That could have a real impact on FX rate. In fact, the maybe-taper-someday did shift the market considerably. Will a real taper announcement do the same? Probably.

MAS: The 1000lb gorilla is still MAS. And MAS wants an appreciating SGD. In fact, MAS will do everything in its considerable power to get it (see inflation). In the long term MAS has proved capable of controlling FX rates. So in the short/medium term it will pull for a drop in USD/SGD. Can it that in face of a QE taper? Probably. Might it allow a one time shift in the policy band but with increased slope? Possibly.

Likely outcomes:

1) USD/SGD has hit the bound - gradual drop for 3 to 6 months down to 1.22 (extreme) to 1.245 (mid-band)
2) Taper reaction wins - USD/SGD sits still in short term, taper arrives, USD/SGD shoots up at end of the year to... 1.3? 1.35?
3) Taper induces 'one-time' shift followed by SGD appreciation - USD/SGD goes up, possibly as high as 1.4 in Oct/Nov, then falls rapidly over following six months to... 1.3? 1.25?

Any thoughts from readers will be highly appreciated.