Hidden risks of USD fixed deposits for Singapore investors

In the quest for higher “risk-free returns”,  many Singapore-based investors are increasingly turning towards the alluring prospect of USD fixed deposits and money market funds due to the higher USD interest rates. 

Banks and investment platforms have also marketed the attractive 5+% yields of USD deposits. 

In this article, we will look at the fundamentals of these USD products, the risks, the hidden costs Singapore-based investors take on, and how they should holistically think about foreign currency exposure for their different financial goals.

Why do many investors favour USD fixed deposits?

Higher yield relative to other major currencies

Fixed deposits and money market funds track the yields of the respective country’s treasury bills and government bonds very closely. The data above shows that USD offers the most attractive yield at the short end of the yield curve.

Perception of USD as a safe haven

The USD has been the world's primary reserve currency since the end of WWII, and it is also the most widely used currency for international trade and transactions. Central banks globally hold approximately 60% of their reserves in USD, and this status provides inherent stability and trust.

Furthermore, the size and stability of the U.S. economy reinforces the dollar’s importance. US stock and bond markets are the largest and most liquid markets in the world, offering investors assurance that they can buy and hold the currency long term.

Risk of investing in USD fixed deposit products

Currency conversion fees

Retail banks offering USD fixed deposits often impose high bid-ask spreads on currency conversions. This high bid-ask spread, often at 0.5% or higher for retail investors, eats into returns. An investor who does not already hold USD would need to buy and sell USD at the start and maturity of the deposit, potentially incurring an FX conversion cost of 1%. A 1% cost is significant relative to a 5+% annualised yield earned.

Currency exposure risk

As Singapore-based investors with SGD liabilities, we should not expose ourselves to short-term currency risk as much as possible. When we invest in USD deposits, we are exposed to the risk that the USD will depreciate relative to SGD. These short-term fluctuations can easily wipe out the higher yield offered by USD deposits relative to SGD deposits.

As seen from the historical rolling 1-month return for USD/SGD, there are instances where there has been a huge depreciation (-4.93%) of USD over SGD. This, combined with FX conversion cost, can easily wipe out any incremental gains from taking on the USD exposure.

Learning from the mistakes of corporations

We have seen instances of large global companies mismanaging their currency exposure, which has led to great financial distress. Petrobras, a Brazilian state-controlled oil company, experienced financial difficulties in 2012 due to currency mismatches between their assets and liabilities.

Petrobras earned its majority of revenue in Brazilian reals but took on mostly USD debt.  When the Brazilian real was devalued against the US dollar in 2012, this significantly increased the company’s debt burden and interest payments, leading to its first loss in 13 years.

Matching FX exposure against personal assets and liabilities 

As individuals, while we may not need to take on SGD debt to invest in USD fixed deposits and money market funds, these investments are typically meant as emergency funds or to pay for short-term obligations like housing down payments, which are denominated in SGD. In these cases, taking FX risk is speculative and akin to gambling in the Forex markets. 

For longer-term investment holdings

Currency fluctuations can be significant in the short term, but as Vanguard has shown, these fluctuations tend to even themselves out in the long run. 

At Endowus, we have consciously chosen to hedge the FX risk of bond allocations in our Flagship Core Portfolios. One of the roles of having fixed income exposure is to diversify and offset the volatility from equities. We recognise that the absolute return on bonds is lower compared to equities, and may not withstand the volatility stemming from currency movements. The cash flow for fixed-income products is also more predictable, and can be hedged with forward contracts or interest rate swaps, for example. 

In contrast, hedging FX for equities is more costly and less precise, given its indefinite holding period and fluctuating dividend schedules. Being invested in equities also means being comfortable with some higher level of risk. 

While current day USD fixed deposits are attractive, most platforms require a minimum investment period to avail those attractive rates. USD cash funds can match these rates, or in some instances even provide better yields, but with some underlying risk. The benefit of these short-term cash funds is in the flexibility that you can withdraw anytime, to deploy your funds for opportune moments. 

At Endowus, we offer a wide range of foreign currency-denominated investment products, both hedged and unhedged for investors’ different investment needs. 

For a Singapore-based investor with assets (savings) and liabilities (spending needs) in SGD, it’s more important for currency exposure to focus on asset-liability matching rather than searching for currencies with higher yields. 

Asset-liability matching is converting assets you may have into more liquid investments when you have a liability coming due. For example, investors may want to sell some of their stocks and place them into cash equivalent investments, like short-term government bonds, that mature around the dates you'll need the money.