20 Apr Market Commentary – April 2022
What are the implications if interest rates rise?
- Deposit rates can be expected to follow the cash rate higher providing much needed relief for savers. Some economists see term deposits increasing by around 30-40 basis points (bps) once the cash rate exceeds 1%.
- Borrowing rates (across all types) will increase, reducing the borrowing levels as well as making debt more expensive. Fixed rates are already rising in line with longer dated bank funding costs. Variable rates are likely to increase by the full amount of the RBA cash rate increase initially.
- Higher rates raise the attractiveness of fixed income investments compared to other (more) risky investments, particularly those which are interest rate sensitive.
- Positive returns from bond investments are still possible during a rate hike cycle albeit weaker than when cash rates are falling and / or stable. The magnitude of weaknesses will be determined by the path of bond yields.
- In relation to the broader economy, higher borrowing rates can lead to a reduction in spending, investment and ultimately unemployment if it begins to slow the economy.
What impact has the war in Ukraine had on forward cash rate hikes?
Since the outbreak in Ukraine, oil and commodity prices have soared and supply chain issues that were beginning to be resolved have instead been exacerbated. This is increasing inflationary pressure at a time when inflation was already elevated due to a combination of factors including goods demand outstripping supply.
On the flip side, the persistent elevated inflation levels do pose a risk to global growth via reducing real incomes (incomes after adjusting for inflation) and then demand, which could cause a slowdown in the global economy. A slowing global growth backdrop would see the need for rates hikes diminish – posing a risk that cash rates will not get as high as both economists and the market are currently forecasting.
Fixed Income Investments looking more attractive
Fixed income investments are looking more attractive to more risky assets. Yields on fixed income investments have risen sharply since the start of the year. In Australia, the 10-year bond has risen by 135 bps to circa 2.8% since the start of the year. Even term deposits are looking interesting again, with interest rates on 12-month term deposits rising rapidly over the last few weeks from an average of 25 bps to levels that range between 40 bps and even over 100 bps depending on the product issuer. However, the risk is that should elevated inflation levels persist, returns on longer dated fixed income investments are likely to be hardest hit.