‘Our Dollar, Your Problem…’

Interest Rates Housing Market

The headline you see above were the famous words of Nixon-era treasury secretary, John Connally back in 1971.

It was a statement at the time designed to shock his international counterparts into reaching an agreement on currency rates before the USA took unilateral action.

And it worked.

The G-10 ministers met again three weeks later at the Smithsonian Institute in Washington and came to an essential agreement on exchange rate policies, which Nixon humbly referred to as ‘the most significant monetary agreement in the history of the world’.

But it underlined a deeper truth that is still with us today.

Fed Reserve speaks, we listen…

America remains the epicentre of the financial world.

Which brings us to Janet Yellen’s statement earlier today.

The Federal Reserve Chair announced two items which on their own seem reasonable enough. However the long term consequences for Australian investors might be more substantial.

A 0.25% rate increase is not a big deal by itself. However, it’s the start of a move to reign in the years of loose money.

Again that’s a good thing.

She coupled this with an upbeat assessment of the US economy and an intention to start unwinding the $4.5 trillion Fed balance sheet, mostly a mixture of treasury, mortgage and government debt.

Without going into the nitty gritty, the basic outcome is the US leading the world in increasing interest rates, albeit slowly and steadily.

Meanwhile, down in Australia…

Back in Australia, interest rate rises are not on the horizon as yet.

Despite government projections of 3.5% wage increases, the reality is the average is currently closer to 2%.

Couple this with record high home loan debts, and some predicting two subsequent quarters of negative growth (a technical recession) soon, interest rates are more likely to go down than up for us in the short term.

Which brings us to…

The Australian dollar versus the US dollar.

Basic economics tells us that when US interest rates rise relative to Australian interest rates, the Australian dollar will fall.

And the last time US interest rates were higher than Australian interest rates, the Australian dollar was just US48c.

But conversely, Australian banks may need to borrow money from overseas at higher rates to make up the funding gap we have between our domestic savings and borrowings.

That would result in, wait for it….higher mortgage rates! And also higher corporate bond rates for companies with any debts issued in US dollars.

The basic point

The US has the potential to, unintentionally, be our problem.

Always has, always will.

This complex web of financial and economic links have the potential to unleash black swan events at any time.

These are events no one expects until they happen.

But they will happen.

Regards,

Ryan Dinse

Ryan Dinse

Ryan Dinse

Ryan Dinse is an analyst at Markets and Money.

He has two decades of experience in financial planning, equity analysis and credit markets.

Ryan combines fundamental, technical and economic

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