Low cost and low volatility make the Singapore dollar a new favorite funding currency for carry traders.

Strategists say that low borrowing costs and diminished appreciation expectations are increasing the Singapore dollar's appeal as a funding currency for carry trades, giving it an edge over the yen. Last week, the Monetary Authority of Singapore (MAS) unexpectedly kept monetary policy unchanged, reinforcing expectations that the Singapore dollar's appreciation will be more limited after the tightening moves in April and July. At the same time, strong safe-haven inflows into Singapore have left local money markets flush with liquidity, pushing down forward implied yields. That gauge is seen as a measure of short-term borrowing costs. The combination of low-cost funding and low exchange-rate volatility has boosted the Singapore dollar's appeal to carry traders. Carry trades typically involve investors borrowing in low-interest-rate, low-volatility currencies and buying other higher-yielding assets to capture the interest-rate differential. By contrast, Bank of Japan rate hikes are pushing up yen borrowing costs and increasing the risk of further yen appreciation. Abbas Keshvani, Asia macro strategist at RBC Capital Markets, said: "Funding in SGD is attractive as the implied yield of the Singapore currency is lower than most other currencies and there is limited upside for the SGD, resulting in a negative carry." He added that, by contrast, yen funding faces the risk of further policy normalization by the Bank of Japan. The divergence in the two central banks' paths underscores the shift. The Bank of Japan raised its policy rate by 25 basis points in September, and swap-market pricing shows an 80% probability of another 25-basis-point hike before December. This hawkish backdrop has supported a 2.7% rise in the yen against the dollar since the second half of this year, while the Singapore dollar gained only 1.3% against the dollar over the same period. Data show that the three-month forward implied yield on the Singapore dollar is hovering around 1.65%, placing it alongside the yen and the Swiss franc among the currencies with the lowest funding costs out of 38 developed and emerging-market currencies. Singapore dollar volatility has also declined, reducing the risk that exchange-rate swings erode the extra returns from carry trades. Three-month implied volatility on USD/SGD has fallen to 3.55%, the largest drop among comparable Southeast Asian currencies over the past year. Dwyfor Evans, head of Asia-Pacific macro strategy at State Street Markets, said the Singapore dollar's interest rates are lower than those of typical high-yielding currencies, so it can serve as a funding currency for carry trades. The MAS decision may reinforce that appeal. The MAS uses the exchange rate rather than interest rates as its main policy tool. This month's decision to keep the exchange-rate policy band unchanged marked a pause after several consecutive rounds of tightening. HSBC HOLDINGS strategist Joey Chew wrote in a report: "We think the market will re-adopt SGD as a potential regional funding currency. SGD has been facing downward pressure, likely stemming from its low interest rates."