The bonds connection

It’s hard to write about this subject, but bonds is something that cannot be left out of the equation. i have been pondering for some time what part bonds play in interest rate movements. Does the bond yield lead or trail interest rates? Lets explore that.

For one thing, mortgages in the US are closely linked to bond yield, especially the 10-year Treasury Note. This article explains

Fixed mortgage rates typically track the yield on the 10-year treasury note. “The 30-year mortgage tends to have roughly the same [sensitivity to interest-rate changes] as a 10-year treasury,” says T.J. Marta, a fixed-income strategist at RBC Capital Markets. “On average, people pay off their mortgage roughly every 10 years.” The outlook for inflation plays a key role in determining the yield on the 10-year treasury, Marta says.

In order to compensate lenders and investors for the risk that home loans will not be repaid, mortgage interest rates are set higher than the yields on 10-year treasuries, which are essentially risk free. Historically, the typical difference between mortgage rates and the 10-year treasury yield””known as the spread””has been roughly 1½ percentage points. In the mortgage industry, the difference between these two rates is often referred to as a “risk premium.”

However, that is where the relation ends, as many will tell you (see also this article). Basically long term interest rates are not correlated with short term interest rates, so we can leave the 10 years and above bonds out of the picture. Instead, we want to look at how short term treasuries are related to fed funds rates.

Some googling around leads to this insightful forum thread comment – “The main influence on the T-bill yield is the anticipated FFR. It would be surprising if the T-bill yield did NOT lead FFR.  I would expect the market to have a better idea of what the Fed will do than the Fed itself. That said, the T-bill yield is not the best leading indicator of the FFR. A better leading indicator is the FFR futures rate. That is because there are other influences on the T-bill yield.” So the 3 months treasury bill yield and the Fed Funds Rate Futures are useful lead indicators of the Fed Funds Rate.

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Fed funds rate unchanged at 2%

The Federal Open Market Committee (FOMC) has kept the federal funds rate at 2.0% – news that is not news since it was widely anticipated. What is more important to note perhaps, is that “in its statement, the Fed gave no sign that it plans to change policy in the foreseeable future.”

Excerpts from news sources

  • many economists believe the Fed won’t move rates in either direction until after the presidential election
  • the Fed will keep rates at 2% until at least December, if not early next year
  • unless a major bank goes under, the Fed’s next move will be to eventually raise rates

SIBOR and SOR have been trending lower recently. Lets hope it will stay that way at least until early next year so i can capitalize on it, heh.

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Studies have shown..

Found another article explaining Interbank Interest Rate Determination in Singapore. Published in 1999 by the Monetary Authority of Singapore (MAS), it stipulates that

Only changes in US interest rates or market expectations of future movements in the exchange rate have a significant impact on the domestic interbank rate.

That should be enough proof that SIBOR and SOR tracks interest rates in the US. This chart of the US 3 months interbank rate may be a useful resource.

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Interest rate parity

One step forward in my quest on what moves interest ratesinterest rate parity. Simply put, this theory states that

the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate.

In other words, the total sum (principal + interest) in currency A at the end of a given time period should equal the total sum if currency A is first converted into currency B, invested for interest, and converted back to currency A at the end of the same period.

This is one reason behind lower interest rates in Singapore, as the Singapore dollar has appreciated against the US dollar over the last one year. The interest rate parity theory can only be used as a guide though. As explained in this article, Singapore interest rates have been lower than the implied rates from the interest-parity modelling:

Singapore’s domestic short-term interest rates have since April [2007]stayed below the implied short-term rates suggested by our equilibrium interest-parity modelling. We suspect that this reflects a deliberate strategy by the MAS to maintain enough liquidity in the local system to keep domestic interest rates low and shield the Singapore dollar from becoming a target currency for the yen carry trade.

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Fixed rate package interest rates trending up

Since fixed rate home loan rates are rarely published online, i decided to do a survey in person. I went to a bank i have been to five months back and found out that indeed the 1 year fixed rate package is now at 3.68% as reported. The last time i was there it was 2.68%, a whopping 1% increase!

The fixed rate package scheme is a tricky business for banks. Banks will have to make a good guess as to what interest rates will be like in 2 or 3 years’ time. If the rates turn out to be higher than expected, they will be paying higher interests on the cash that they in turn are loaning out and their margins will be squeezed. Hence banks have to be very conservative and quote a safe (as in high) rate.

Looking at the way interest rates are moving, i must say that people who have chosen a 2 or 3 years lock-in five months ago have chosen wisely. They can have peace of mind for the next 2 or 3 years. For the rest of us who can stomach more risk in opting for variable rate packages, lets hope the current savings in interests will still be able to offset the increase in future interest payments, and lets hope your investments will do better than 4%. All the best!

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What moves interest rates

Every home owner who cares about how much monthly installment and interest they pay should be interested to know, what moves interest rates? Specifically, what determines the home loan rates here in Singapore? It is often said in news articles that Singapore rates track the United States Federal Reserve rate. That almost seem like too easy an answer. Fine. The obvious question to ask next – so what moves the Federal Reserve rate?

In their own words, the Federal Reserve states that they are the central bank of the United States, with duties to

  • conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment,
    stable prices, and moderate long-term interest rates
  • supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
  • maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
  • providing financial services to depository institutions, the U.S. government,
    and foreign official institutions, including playing a major role in operating the nation’s payments system

One of the primary tools they use to fulfill these duties is to suggest what the overnight inter-bank lending rate (commonly known as the Federal Funds rate) should be. The whole world watches and anticipates the outcome of the Federal Open Market Committee (FOMC) meetings which reports their conclusions on the Federal Funds rates. The meeting calendars are published here. In between the dates of those meetings, the whole world watches what the FOMC members say. And they do say much.

A recent speech by an FOMC member managed to convince the market somewhat that the Fed rates is set to increase soon.

“Inflation is already too high and inconsistent with our goal of – and responsibility to ensure – price stability,” Plosser said in a speech to a group assembled by the Philadelphia Business Journal. “We will need to reverse course – the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later,” he warned. “And, I believe it will likely need to begin before either the labour market or the financial markets have completely turned around,” he added.

This insightful article, however, gives reasons why the Federal Reserve can’t raise interest rates just yet.

While it’s true that maintaining low interest rates will further fuel inflation, the Fed really has no choice. Or perhaps it’s a Hobson’s choice. You see, if the central bank actually raises rates to combat inflation, adjustable rates on mortgages will rise, setting in motion a whole new round of housing defaults, which will lead to an escalation of bank write-downs, which will torpedo stock prices, which will force institutional investors to liquidate holdings to raise capital. The same will happen out in the marketplace, where companies with debt coming due will find it impossible to refinance, touching off still another avenue of defaults, losses, and write-downs.

Interest rates will go up as this article explains.

at some point inflation fears rise to a level where aggressive rate hikes by the Fed are needed to bring about a REDUCTION in long-term interest rates.. even if the economy remains weak.

So do watch out for interest rates movements.

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Singapore SOR falls to 1.09

SOR has fallen consecutively for 3 days to a new low of 1.09%!

SIBOR or SOR pegged loan packages may be drawing more interest now that there are no more cheap mortgages as banks raise rates. Quoting from the Jun 12 article:

No more cheap mortgages as banks raise rates UOB and OCBC Bank have raised rates for their three-year, fixed-rate mortgages to 3.68 per cent from 2.98 per cent. Standard Chartered Bank has raised its rate for its two-year, fixed-rate package to 3.78 per cent a year from about 2.68 per cent .. market players may now be raising rates to squeeze higher margins from new loans

At the same time, banks seem to be fighting for customers in the SIBOR or SOR pegged loan segment, as is evident from the new loan package from HSBC featuring a decreasing interest rate spread. This article explains:

Under the new loyalty package, the customer pays the 3-month Sibor rate plus 0.75 per cent in the first year; in the second year, he pays 3-month Sibor plus 0.65 per cent; and from the third year onwards, the rate is 3-month Sibor plus 0.55 per cent. The 3-month Sibor on July 1 was 1.25 per cent.

Banks may be raising their fixed-rate mortgages in anticipation of interest rate increases by 2H08 and beyond. There has been repeated calls to raise interest rates to counter inflation. Meanwhile, it may be worthwhile taking up a SIBOR or SOR pegged loan since they typically come with minimal or no lock-in period, making it possible to switch to a fixed-rate package when broad interest rate hikes really take place.

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Beginner Barista with Krups XP4020

krupsxp4020

So i’ve had my Krups XP4020 for a month now and i’m just starting to get the hang of making coffee proper. If you are a new owner of an espresso machine, hit the net and check out the bountiful resources that teaches you barista know-how. Here are some beginner skills i learned.

First stop, making espresso. You need to make sure the ground beans are properly tamped down. Watch this video for a demonstration on how it’s done. There’s even a lengthy discourse on the science of tamping if you’re interested.

Next, frothing the milk. The trick is to use cold milk so you have sufficient time for frothing it before it gets too warm and starts boiling. I put the milk into the freezer before i start just to make sure it gets a little colder. Experiment with different brands of milk to see which will give you the best results of frothy milk that stays frothy while having the right taste. Again, here’s an excellent video on frothing milk (and another one) . Do read the comments on how to get better froth with your Krups XP4020 if you’re using one. Also notice that the container for the milk is typically a stainless steel pitcher. Here’s an article that says why. I need to try some of these suggestions myself.

What are my thoughts about this machine? I guess it works great as an entry level machine for someone new to making espresso. I have the same gripe that many others have about the plasticky tasting coffee when you first start using it. That taste comes mostly from the water tank. I followed the advice of a forum posting and stuffed newspaper into the water tank and i think the idea actually worked quite well in reducing the plastic taste. Still, it makes me worry to see plastic on the steam wand seemingly melting under the heat of the steam passing through it. If ever i will get a new machine i am going to make sure that it has a stainless steel steam wand and minimal plastic parts.

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Unlimited calls through mobile broadband

fringiphone

Here are further ideas on how to take advantage of VOIP.

Assuming that you subscribe to a mobile broadband plan (as discussed in my previous post) and you also have a home phone line (that allows you to make cheap or free calls) plus broadband internet, you can forward calls between your home phone line and VOIP. This should prove to be quite economical since many people would already have a phone line and broadband internet to begin with. In any case, a phone line + broadband internet combo is relatively cheap. Here are samples of available plans:

US – AT&T Double Pack US$65 includes 1.5Mbps broadband and nationwide long distance calls
UK – Tiscali Broadband and Talk £14.99 includes 8Mbps broadband and UK phone calls
Singapore – Singtel Mio Plan S$55.80 includes 3Mbps broadband, unlimited local calls and 100 mins mobile plan

To forward calls between a phone line and VOIP, you need an Analogue Telephony Adaptor (ATA). What an ATA does is to answer incoming calls on the phone line and initiate a VOIP call, or vice versa, make a call on the phone line when a VOIP call is initiated. This allows you to receive and make calls through mobile broadband and the home phone line, both of which are cheap, instead of your more expensive regular mobile line. Examples of relatively affordable ATA are the Linksys SPA 3102 and the Grandstream HT-503. These are even capable of handling Caller ID from both VOIP and the regular phone line so you will know who is calling you. Setting up the ATA to perform call forwarding may be a very difficult process though, so be warned. A configuration wizard is available here that may help if you are setting up the Linksys SPA 3102.

To avoid the hassle of setting up call forwarding that i just described, you could opt to sign up with a VOIP Service Provider (VSP) and have them handle all your VOIP calls. They will take care of routing calls to and from regular phone lines and calls will work almost exactly the same way as your regular mobile/cell phone, except that it goes through a VOIP client application running over mobile broadband. If you deem the mobile broadband connection to be reliable enough, you can even terminate your mobile/cell phone subscription and use VOIP on mobile broadband exclusively. To play safe though, you can take up a pre-paid pay-as-you-go mobile plan as a backup.

In the future all these will not be necessary as Telcos have no choice but to offer the very same VOIP services, as telephony transits onto an all-IP platform. The internet continues to level the playing ground for businesses and we are about to witness Telcos losing their monopoly over voice and messaging communication.

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