As investors, we want alpha – also known as excess return on our investments. Whether for our short-term goals or for our retirement in our golden years, we want to grow our wealth as quickly and as much as possible.
However, given the current hyper-inflationary environment and resulting rate hikes, ongoing geopolitical tensions and supply chain disruptions, some investors have viewed Singapore Savings Bonds (SSBs) as a safe haven and haven against market volatility. forced to take.
In fact, SSB demand continues to grow in the first half of 2022, with a record $2.4 billion in applications for the August 2022 issue (GX22080V) with a bid size of around $700 million. For comparison, the size of August’s offering is more than four times the size of January 2022’s $150 million.
The reason for this increased demand for SSBs is that both first-year and ten-year average interest rates have steadily increased, reaching as high as 2% and 3%, respectively.
Then you might be wondering if you missed the boat or if there will be a higher yielding SSB in later issuance. To answer this, we explain how the interest rate on SSB is composed and why it is now increasing.
Review of the characteristics of Singapore Savings Bonds
Before delving deeper into this article, let’s first take a look at the unique characteristics of Singapore Savings Bonds (SSBs) compared to other types of Singapore Government Securities (SGS).
Similar to other SGS bonds and Treasury Bills (T-Bills), Singapore Savings Bonds (SSBs), issued by the Government of Singapore and fully guaranteed, have the highest credit rating of “AAA”, indicating a low risk of default.
Unlike other bonds, however, SSBs differ in that they are issued with a flexible 10-year term, allowing you to repay your investment in any month until the loan matures without penalty. In addition, the interest or coupon rates on SSBs are determined based on the average long-term SGS yields of the previous month.
Finally, SSBs have a rate-boosting feature, where the initial interest rates, set and locked in for each issue, increase over time until the bond matures.
Also read: [2022 Edition] The Complete Guide to Buying Singapore Savings Bonds (SSBs)
How is the coupon rate for SSB calculated?
First, we need to understand that there are two components to the formulation of SSB’s coupon rates. The first is the SGS benchmark yield and the second is based on the step-up facility of savings bonds.
SSB coupon rates are compared to the SGS yield
The coupon rates on each issue of SSB are linked to longer-term maturities, specifically to the benchmark 1-, 2-, 5- and 10-year Singapore Government Securities (SGS) yields. These reference yields are calculated based on the simple average of the respective daily SGS benchmark yields for one month prior to the public announcement of the issue.
Simply put, an investor’s average annual total return should equal the return to maturity of the relevant SGS (e.g. 5-year SGS) over a holding period (e.g. 5 years). For example, we compare the coupon rates for the September 2022 issue (GX22090Z) to the August average daily SGS benchmark yield.
Using the table above, we can see that the compounding rates of SSBs are equal or close to the previous month’s average daily SGS return for the respective holding period.
A possible exception where this cannot happen is the small rounding difference of up to +/- 0.03% that can arise when calculating the average return for SSBs.
SSB coupon rates may be adjusted to maintain the step-up interest facility
A second scenario that may affect SSB coupon rates is that the SGS Reference Yield does not allow for a monotonically increasing step-up interest facility for the relevant SSB issue (i.e. the SGS Reference Yield implied based on the coupon rates may partially be reduced or the entire term of the issue).
This occurs when either some or all of the longer-term reference yields are lower than the short-term reference yields (ie an inverted yield curve); or when a given benchmark return is much higher than immediately before but not much lower than immediately after (e.g., a five-year return is significantly higher than a two-year return but not less than a ten-year return). is-year yield). This is known as a “highly convex yield curve”.
In such a scenario, the Monetary Authority of Singapore (MAS) may lower coupon rates below the minimum required to sustain an increasingly stringent coupon schedule. In other words, coupon rates may be low in the early years, but they will eventually rise in later years while being adjusted for the time value of money based on risk-free discount rates. This is done to encourage long-term savings, which is also the intention of SSBs.
So while you might be affected by a lower average compound yield in the short-term, if you hold it to maturity, it won’t impact the yield on the SSB issue. The average compound coupon rate of the SSB always corresponds to the ten-year reference yield.
Also Read: 5 Reasons Why Investing in Singapore Savings Bonds (SSBs) Makes Sense in 2022
Why are SSB coupon rates increasing?
SSB coupon rates are only rising because benchmark SGS yields are also trending higher in 2022.
The central bank of the United States, the Federal Reserve (Fed), raised interest rates sharply ahead of 2022 to cushion increasingly high inflation. As a small and open economy, Singapore uses the exchange rate rather than the interest rate as the main policy tool. Therefore, its interest rates are affected by global interest rates, particularly those of the United States.
Therefore, we can expect SGS yields to follow a similar trend as US Fed Funds interest rates, which in turn will affect SSB coupon rates. Looking ahead, we can expect SSB coupon rates to increase or stay high in a rising interest rate environment.
Also read: Fighting inflation in Singapore: what can MAS do (and at what cost)?
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