ABE Weekly: RBA makes waves, leaving some investors in deep water

Australian Bond Exchange Weekly Newsletter

Friday 5th May 2023

Key Points

Market economists left shocked as the Reserve Bank of Australia (RBA) hikes cash rate to 3.85%, with mixed rhetoric causing confusion.

US and EU central banks increase cash rates by 25bps, and although some analysts forecast US cuts as early as December, the EU is set to hike further
Price pressures on equity and property investors as ASX drops and investment loan rates increase, revealing high yield opportunities in bond markets.
“Free” money lending and near-zero interest rates has led to a strange new world of “stagflation” combining slow growth, high inflation and rising interest rates.

Global Cash Rates & Inflation*

Australia: The Reserve Bank of Australia (RBA) increased the cash rate to 3.85% to tame an inflation rate 7.0%. The next rate decision is Tuesday 6th June at 2.30pm
UK: The Bank of England (BOE) cash rate is at 4.5%, and inflation is at 10.1%, with the next monetary policy decision on Thursday 11th May at 12pm (9pm AEST)
US: The Federal Reserve cash rate (policy rate) was increased to 5-5.25% this week with inflation sitting at 5%, with the next decision due for Wednesday 14th June
EU: The ECB Cash Rate (main deposit rate) is now 3.25% raised 25bps on Thursday 4th May to curb inflation which sits at 6.9%, with the next review set for Thursday 15th June

Market economists left shocked as RBA hikes the cash rate to 3.85%

Prior to the RBA’s announcement yesterday, Australian economists priced in a mere 13% chance that the cash rate would increase, but with inflation still well above the target rate of 2-3% and unemployment at a near 50-year low, the RBA made the call to increase the rate to 3.85%, which has caused some contention amongst market analysts.

Tuesday's hike brought further volatility and increasing risk to equity investors dropping Australian shares by a quarter of a per cent almost immediately after the news was released.

For property investors, the outlook’s not much better, with CoreLogic research showing that even though rental prices rose by 10.1% over the 12 months to April, repayments on investment loans have increased much faster than rents.

Bond investors likely main benefactors of interest rate rises

If the RBA’s response to inflation is to continue to hike interest rates, bond investors could benefit as the equity market becomes more volatile. Due to the inverse relationship bond prices have with interest rates – as in when interest rates go up, the prices of bonds go down - there’s an opportunity for bond investors to get an additional return, on top of their regular coupon payments.

When interest rates are high, and the bond price drops below the face value of the bond, investors can collect the difference when the bond matures – if they hold it to the maturity date. For example, if you buy a bond now at $93 and it has a face value of $100, and you invest $100,000 you’ll earn an additional $7,000 on top of the coupon payments.

If you want to know more about the returns you can make in such a strange and volatile market, get in touch with an adviser on 1800 319 769 or request a callback here.

The economic impact of “free” money, and the truth about inflation

It is unclear exactly how central banks and governments will successfully solve the economic dilemma brought on by an unprecedented era of “free money” lending, near zero cash rates, and in some European countries negative rates, during the COVID pandemic.

After essentially turning off the global economy to stop the spread of COVID, a strange new world has emerged. Low economic growth, high inflation and rising interest rates, is creating what some commentators have labelled “stagflation”. This, coupled with low supply and high demand, makes it hard for markets to predict what’s next.

The current complexity of the global economy is also creating confusion among everyday Australians, as inflation rates may be “dropping” but it’s still way above the RBA cash rate target range of 2-3%.

So, what next?

Could UK market analysts be as shocked as Australia’s leading economic commentators when the cash rate decision is made on the 11th May? Is the Bank of England prepared to tighten monetary policy by increasing more than 25bps to tame double digit inflation?

If they do, will this impact the RBA’s decision in June?

In his speech on Tuesday night at the Reserve Bank Board Dinner in Perth, RBA Governor Philip Lowe confirmed that although “the peak in inflation in Australia is now behind us, that has not changed our view that it will be some time yet before inflation is back in the target range.”

The answers to these questions are likely to cause as much debate as the outcome of the upcoming Australian 2023/2024 Federal Budget announcement next Tuesday 9th May at 7.30pm.

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*Data accurate as at 05.05.2023

Disclaimer: The information and any advice provided in this newsletter has been prepared without considering your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things. You should obtain the relevant appropriate document for any product mentioned and consider its contents before making any decision.