New year. New start. New market predictions.
January is typically a quiet month in the markets. People are still in holiday mode. Central bankers and policymakers are on hiatus. And stock market volume is low.
Which is to say that, outside of the wild crypto swings, there’s generally not a lot of market activity to discuss at the moment.
Except global interest rates, that is…
The Fed is tipped to increase the US cash rate two or three times this year.
With the US cash rate currently sitting at 1.5%, two rate increases of 0.25% would see rates jump to 2%. A third would leave it at 2.25%.
Right now, the US and Australia are at rate parity. But the likelihood is that the Fed will push US interest rates higher than in Australia.
How will US interest rates effect the Australian dollar?
In the past 25 years, the RBA held a lower rate than the Fed between 1997 and 2001. The effects of having a lower interest rate than in the US meant the Aussie dollar was worth between 48–74 US cents over that time.
The upper end of that exchange rate doesn’t look too bad. Yet that was the peak for the period. For most of that period, the Aussie dollar was worth roughly 50 US cents.
However, a weaker Aussie dollar wouldn’t be the worst outcome for the RBA.
Over the past 18 months, the RBA has continually been frustrated by the strong Aussie dollar. Even though the Aussie dollar is getting a boost from stronger commodity prices right now, this should ease as the cyclical January commodities boost fades.
Sitting back and allowing the Aussie dollar to fall as the Fed jacks up rates is probably a happy outcome for the RBA. Not following the US interest rate movements should weaken the Aussie dollar without the RBA having to intervene.
However, that hasn’t stopped calls for rate rises towards the end of 2018. National Australia Bank [ASX:NAB] has a consensus view that the RBA will start increasing the cash rate around August.
In fact, ABC News reported in December last year that mortgage holders should be prepared for at least one rate increase this year from the RBA.
But there’s a problem with that line of thinking.
Just because rates have been at records lows doesn’t mean they can’t go any lower.
Higher interest rates could affect the Aussie property market
For one, there’s the Aussie property market to think about. Higher rates would hurt demand, while hitting existing borrowers hard. Granted, the RBA has contributed to the property market’s rise by keeping rates exceedingly low for far too long.
Nonetheless, over the course of the past three years, the Big Four banks have increased their interest rates on loans in response to a low cash rate. This has gone some way in allowing the banks to control property-lending outcomes.
Additionally, financial regulator APRA is wielding its power over the banking sector. APRA has demanded banks only lend a certain percentage to investors, with restrictions on how much of that can be set aside for interest-only loans.
These moves alone have allowed the RBA to pretend that housing isn’t a major concern anymore.
However, by looking at what the big banks are doing, we can glean what the RBA is likely to do in the future.
This week, the Commonwealth Bank of Australia [ASX:CBA], Westpac Banking Corp [ASX:WBC] and NAB all quietly lowered their base savings rate for long-term customers. This sneaky attack on savers means customers are now getting less in return for cash held at their respective bank.
There are suggestions that with mortgage competition between the big banks slowing, there’s less need to acquire savings deposits from customers to fund the banks.
It’s highly likely the banks are preparing their balance sheets ahead of potential incoming rate cuts from the RBA.
I have suggested over the last year that persistently low inflation would prevent any RBA rate rise this year, leading to a rate cut instead.
Credit Suisse has now come out saying that the RBA’s own forecasts are too optimistic. Credit Suisse reckons that an increasing savings rate for customers would further dampen spending, causing inflation to remain at current levels. Importantly, a rate rise would only slow the RBA’s desire for inflation growth.
Morgan Stanley, in a recent note to clients, highlighted low inflation as preventing the RBA from jacking up rates. But it also said that low wage growth is a major contributing factor to any interest rate decision. Furthermore, it suggested that price declines are likely to further hurt consumption.
In other words, if people’s homes are worth less than before, they’ll feel poorer. If they reckon they’re broke, they’ll spend less. All of which feeds into slowing consumption and even less growth inflation.
My takeaway? Get set for a rate cut from the RBA this year.
Editor, Markets & Money
PS: Want to know how interest rates work? Find out here.