At this time of year, there’s usually not much in the way of exciting market news.
But December 2017 is an exception. This month has been an interesting time in the markets.
It began on Sunday.
Crypto futures trading
The first ever cryptocurrency futures contracts began trading in the US. The contracts rose 26% in the first few hours of trade. So eager were the punters for a way to trade cryptos that the trading circuit breakers triggered twice.
That sort of volatility to kick off a new product is unheard of.
But that’s only the start. This week, the Federal Reserve Bank meets to decide on interest rates.
Unlike some of the recent Fed meetings, this one matters…perhaps more so for Aussies than Americans.
Let me explain…
The widely-anticipated December rate rise from the Fed is likely to be the last one under current Fed chairperson Janet Yellen.
This likely rate rise is the one the markets thought they were getting in September. So far this year, the Fed raised the cash rate in March and June.
However, at the June meeting, the Fed said that a September increase wasn’t on the cards. Inflation was still low at that point; you could say that the Fed took a breather, waiting for a stronger economic outlook to pursue a change in policy.
While Yellen may have kept rates on hold in September, she has continued to remind the market that a rate rise was nevertheless on the way.
Furthermore, markets reckon Yellen is going to signal that there are more increases coming next year.
As Bloomberg reports:
‘With the world economy heading into its strongest period since 2011, Citigroup Inc. and JP Morgan Chase & Co. predict average interest rates across advanced economies will climb at least 1 percent next year in what would be the largest increase since 2006.
‘[This] reflects an increasingly synchronized global expansion finally strong enough to spur inflation, albeit modestly. The test for policy markets, including incoming Federal Reserve Chair Jerome Powell, will be whether they can continue pulling back without derailing demand or rocking asset markets.’
In addition to this, we have a bumper 18 hours ahead of us. The central banks of Switzerland, Canada, the UK and the European Union are meeting to discuss interest rate policymaking. At this stage, only Canada is tipped to follow the Fed in raising rates. The Bank of England, the European Central Bank and the Swiss National Bank are most likely going to leave their respective interest rates on hold.
But it’s not what the other central banks do from here that should concern you. Instead, it’s what the Fed does that could become problematic.
Both Citibank and JPMorgan Chase reckon the Fed will raise rates either three of four times. If the Fed increases the cash rate even once — a 0.25% rise — it will leave the US interest rate at 1.50%. That’s the same level as Australia. Which is where the problem arises.
Right now Australia enjoys what’s called the ‘yield advantage’ over the US. Our base rate is higher than in the US. Having a higher interest rate helps encourage foreign capital into the country.
Not only that, a higher comparative rate helps keep the Aussie dollar stronger than it might otherwise be. If our cash rate is the same as other major economies — or lower — the dollar is likely to fall.
Problems with a strong Aussie dollar
Now, contrary to what the Reserve Bank of Australia tells you, there are problems with a strong Aussie dollar.
A lower Aussie dollar may benefit the commodity sector and other export-reliant businesses. But it also drives up prices for consumers. Because we import so many goods, a lower currency means that you’ll pay more for goods.
Once we hit rate parity with the US, we lose our yield advantage.
If we lose this, it will likely weaken the Aussie dollar, which may drop well below 70 US cents.
This creates another problem for the RBA: While the RBA may want inflation, a lower Aussie dollar means we are at risk of importing inflation through higher prices. In other words, the RBA wants inflation through economic expansion, and not through imported inflation on the back of rate policies among international central banks.
In my view, it all points to one thing: We’re about to see the Aussie dollar fall this Christmas.
Editor, Markets & Money
PS: One of the problems associated with low interest rates is that investors struggle to earn a reliable income. Matt Hibbard, editor of Total Income, says investors should be looking to ensure they receive a steady stream of income each year. How? Details here.