With the noticeable lessening of market volatility over the past of couple of months, we have seen some substantial recovery gains in the markets. There has certainly been stabilisation and, also, an apparent regained awareness of how things may look post the inflationary driven fears that had dragged the markets downwards for much of the year. People, businesses, governments, and central banks have all had to adapt from the years of very low interest rates to the more normalised rates we are now seeing. Solid corporate earnings have also supported the positive market moves in recent weeks.

Presently, we appear to be in a holding pattern to find if an easing of interest rate tightening will happen. Earlier this year, central banks probably started to pull back the joystick on raising rates a bit late but then went full throttle with rate rises, albeit these were anticipated in the main. As mentioned in last month’s newsletter, we are very  likely to see the key central banks do one more rate rise in the US, Europe and here next month, and then really assess the impact of the sequence of rate rises made in stemming or possibly reversing inflation. The markets recent rallies seem to underpin this view. Markets tend to front run actuality, but they can get it wrong on occasion too!

So, maybe, to hold interest rates steady for a while in 2023? I really think the undertaken rate rises need to be given time to be gauged for their impact rather than continue with further rate rises next year, which would certainly increase the chances of undesired recessionary economic consequences. It is hard to envisage that the rate rises to date are not having effect on certainly the dampening demand side of inflation. I also think that with the passage of time, we are also seeing the supply line constraints and shortages improving. The improvement of supply chains will help stifle consequential inflation pressures. Alas, all just seems to be taking time!

This lessening of or maybe even ceasing of further rate tightening next year is being factored into the markets as we have seen. If the inflation ‘worm’ begins to turn downwards then this anticipation should see reality. If not, and inflation remains stubbornly high, additional rate rises could be implemented by central banks. Steady judgement is needed.

Reading a recent article from the fund manager, Investors Mutual, in it makes a couple of interesting observations as to why it considers rate rises will have a faster inflation dampening impact in Australia than that in the US. It notes that Australian household debt sits at a (gulp!) 202% of net disposable household income, which is one of the highest in the developed world. By contrast US household debt sits at 101% of disposable income which is exactly half that of Australia’s. This means that any increase in consumer interest rates through an increase in mortgage, personal loans or credit card rates hits Australian households twice as hard as those in the US.

Investors Mutual also interestingly note that in the US around 95% of existing residential mortgages are on 30-year fixed rate loans which means that repayments for the vast majority of existing mortgage holders in the US, do not change at all in the current environment. However, in Australia, it is a very different situation with over 60% of Australian residential mortgages being at variable rates. And, as we have seen over the seven-interest rate rises in Australia this year to date, whenever the RBA raises official interest rates this increase is passed on in full by lenders to mortgage holders. This has meant loan repayments have gone up seven times already this year, and very likely at least one more to go next month!

Servicing a mortgage and other personal debt is costing more and more both in dollars and in cash flow outlay. With reducing property prices but high debt levels, many people will feel less comfortable and less able in spending on other things all round. Bottom line is that with these aspects combined, it appears that inflation should show signs of tapering off, and even reverse faster here in Australia than in the US.

So, you would have to think, and hope, that inflation here is peaking, and should then start declining to more normalised levels. Amusingly, compared to only a couple of years ago, you have to ponder how the reverse fear held by economists was that there was virtually no inflation and what that meant to lack of global growth of note! Having annual inflation somewhere between the target zone of 2% and 3% seems to be the ‘fearless zone’!

As Fidelity International state in their Outlook for 2023, “…If central banks remain excessively hawkish and negative, and over tighten monetary conditions through a mix of interest rate hikes and quantitative tightening, there is a risk of an inflationary bust this year, with economies struggling to mitigate the damage. This could hurt both the real economy and asset prices”.

Fidelity International also note that, over a longer time horizon, “…we see no reason for undue pessimism. Economies will survive particular bout of challenges and doubtless emerge stronger when they do. As long-term investors, it is important not to lose sight of the big picture, but to be alert to opportunities along the way”.

Even though this year has been challenging for investors with the market gyrations, it has also presented good opportunities to build on more investment assets to portfolios. Buying and holding quality assets is the core of a long-term successful investment strategy. With interest rates rising it has also widened the pool of investment asset choices. Of course, buying them when cheaper, as has certainly been the case this year, enhances that success!

As always, should you have any queries please do not hesitate to contact us.