Low cost and low volatility support the Singapore dollar as a “new favorite” for arbitrage traders to finance

The Zhitong Finance App learned that due to low borrowing costs and weakening expectations of appreciation, the attractiveness of the Singapore dollar as a financing currency for arbitrage transactions is rising, and it has an advantage over the yen.

Last week, the Monetary Authority of Singapore (MAS) unexpectedly kept its monetary policy unchanged, strengthening the market's expectations that the Singapore dollar would rise more limited after tightening the policy in April and July. At the same time, strong safe-haven capital flowed into Singapore, making the local currency market well-capitalized and depressing the implied forward rate of return. This indicator is viewed as a measure of the cost of short-term borrowing.

The combination of low cost financing and low exchange rate fluctuations made the Singapore dollar attractive to arbitrage traders. The so-called arbitrage transaction usually refers to investors borrowing currencies with low interest rates and low volatility, and then buying other high-yield assets to earn interest spreads. In contrast, the Bank of Japan's interest rate hike is driving up the cost of borrowing yen and increasing the risk of further appreciation of the yen.

Abbas Keshvani, an Asian macro strategist at RBC Capital Markets, said, “Since the implied yield of the Singapore currency is lower than most other currencies, and the Singapore dollar has limited room to rise, creating negative holding costs, it is attractive to finance in Singapore dollars.” In contrast, yen financing faces the risk of further policy normalization by the Bank of Japan, he added.

The split in the paths of the two central banks highlights this change. The Bank of Japan raised the policy interest rate by 25 basis points in September. The swap market pricing shows that the probability of raising interest rates by another 25 basis points before December is 80%. This hawkish background has supported the yen's 2.7% rise against the US dollar since the second half of this year, while the Singapore dollar rose only 1.3% against the US dollar during the same period.

According to the data, the three-month implied forward yield of the Singapore dollar hovers around 1.65%. Among the 38 developed and emerging market currencies, it is among the 38 developed and emerging market currencies with the lowest financing costs along with the yen and the Swiss franc.

The volatility of the Singapore dollar has also decreased, reducing the risk that exchange rate fluctuations will erode additional earnings from arbitrage trading. The implied volatility of the USD/SGD three-month option fell to 3.55%, the biggest drop in the past year among similar currencies in Southeast Asia.

Dwyfor Evans, head of Asia Pacific macro strategy at State Street Markets, said that compared with typical high-yield currencies, the Singapore dollar has lower interest rates, so it can be used as a financing currency for arbitrage transactions.

MAS's decision may reinforce this appeal. MAS uses exchange rates rather than interest rates as the main policy tool. The decision to keep the exchange rate policy range unchanged this month marks a standstill after several consecutive rounds of policy tightening.

HSBC Group strategist Joey Chew wrote in the report: “We think the market will once again view the Singapore dollar as a potential financing currency for the region. The Singapore dollar has been facing downward pressure, probably due to low interest rates.”