Analyst warns MAS likely to make further losses

In its annual report released last Thursday, MAS revealed that it has made SGD10.9bn net loss in FY2010/11 (ending March), solely based on FX translation loss due to the strengthening of the SGD. This net loss after accounting for an investment gain of SGD12.3bn implies that the gross FX translation loss was as much as SGD23.2bn. Contributing to the SGD12.3bn investment gain was around SGD63bn increase in total cash and forward reserves, from USD257bn to USD335bn. The simple rate of return works out to be only 3.2%.

All this suggests that the MAS' FX intervention policy has become extremely costly. We could even question the effectiveness of the policy since Singapore's inflation has risen from 3.2%yoy to 5%yoy during this period, faster than the weighted average increase of its major trade partners.

This is the second time that the central bank recorded a loss since it recorded its first ever loss in FY2008/09. In all the other years, the central bank was mostly also recording huge translation losses but these were easily covered by interest rate gains when global rates - especially US treasury yields - were high.

In the coming year, MAS is likely to make further losses again unless it cuts down on its intervention as well as look for cheaper means of sterilization. In this regard, switching from FX forward swap to issuing MAS bills would at least allow the central bank to enhance its yield return by buying US treasuries or other foreign government bonds, rather than extracting low Libor yields implied from the USD/SGD FX forward curve. We are sure the central bank has already been diversifying its foreign reserves out of US.

The effect of unwinding its FX forward swaps would in fact be the same as conducting unsterilized spot intervention. Hence the strategy to unwind the FX forward swaps and substitute those positions with MAS bills would be a clever one to hold down the SGD, while still sterilizing the liquidity impact through a different instrument. Indeed, MAS recent move to increase the frequency of its bills issuance to twice a week from once a week may signal that it is gradually moving towards this direction.

The 8-week MAS bill will be introduced on 2 Aug, adding to the weekly 4-week MAS bill auctions on Thursdays. The impact on the SGD SOR however would be different than before, since by not rolling or continuing to accumulate its forward positions, the MAS would be releasing liquidity into the FX market. We expect the SOR to continue to fall and not only this, its discount to the SIBOR market will also continue to widen since the SIBOR market is where the MAS bills would be felt most directly.

As such we recommend taking profit on our SGD IRS 2s10s and 1s2s flatteners and suggest switching to receive the 1y1y. We enter the trade at 0.82%, targeting for 0.67% with stop loss at 0.92%. The trade also offers a relatively attractive roll-down of 16bp over 3m.