After a seemingly long and very wet winter, Spring has arrived! Not an obvious change in the weather yet, but let’s hope the warmer weather is just around the corner! Let the sun shine!

Funny how a drop in petrol prices feels so good in these times of rising prices. I filled up the car yesterday at a fuel price of $1.81 per litre. About two weeks’ earlier,  I paid $2.30 per litre, being the normal price at that time.  We have had many months of notable rising prices in almost all goods and services, so it just felt nice that this necessary item, and now more items as well, are reversing the rising price trend which we all have experienced. Is this a sign that prices are retreating more back to the norm; and that the grumble of global inflation is stabilising from these  unusually and concerning high levels of the year to date. Maybe it is.

Albeit slowly happening, the supply side is improving, and the opening up of some spare capacity is helping douse the unusual level of inflation which is believed to be more transitionary in nature rather than being entrenched. In the main, businesses, both large and small, are getting closer to operating as ‘business as usual’. Of course, the reality is now the adapted business as usual in our post-Covid impacted world of how we are all doing business.

It cannot be doubted that the Covid-19 pandemic has been one of the biggest and longest impacting happenings that the world has ever experienced. The world was turned upside down in a very short period of time in early 2020. However, with much concerted effort and the strong human spirit, we are moving on, maybe though a bit jaded from its duration!

So just where are we in this rising interest rate cycle?

For several months now, we are seeing central banks around the globe raise interest rates in response to growing inflation which is well beyond the ‘acceptable 2% to 3% range’. You do want economic growth but not at extreme levels of inflated prices. As we have discussed previously, the demand for goods and services is high, supply is tight, and that also is the case with finding staff, in these times. In a global nutshell, with shortages in supply, and with heightened demand especially backlog of demand, it means extreme levels of inflation are resulting.

If central banks want inflation down, they typically respond by increasing official interest rates (as well as issuing/selling bonds to soak up cash – reverse QE!). This is what is happening now, as we know. Rates will still go higher with the aim to find the right point where inflation is curbed, and then heads back towards the ‘acceptable’ levels. The challenge is to find the correct amount of rate rises, and the right timing of these, to ideally have a ‘soft landing’ that achieves the desired outcome. If it is too much, then it could dampen economic activity to a point where it may trigger a period of too low economic growth or even recession, albeit only likely to be only temporary.

In JP Morgan’s latest Insights, it notes that “Central bankers are not backing down from the inflation challenge. In the past week, the message from both the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) is that rates will have to go higher and remain there longer to curb price pressures.

A key takeaway from the very recent annual symposium of central bankers at Jackson Hole is that inflation in the U.S. is still a problem and more needs to be done to tame price increases, even if this leads to a period of weaker growth. The recent drop in bond yields, and subsequent easing in financial conditions could also have prompted the Fed to reiterate its hawkishness. Fed chair Jerome Powell said that the Fed ‘must keep at it until the job is done and to push inflation down could result in a lower economic growth for a sustained period’ ”.

Our own RBA meets tomorrow, with this very likely to result in Australia’s cash rate to go up 50 bps to 2.35%. Interestingly and positively, rising inflation in Australia is lower than in the US and Europe.

Nevertheless, seeing interest rates rise now is both understandable and acceptable. We are approaching more normalised levels for rates. The consensus appears to be, and is hoped to be, that by the end of this year, central banks should have taken rates to sufficient levels to bring down inflation and therefore stopping further rate rises. It appears that this expectation is being factored into the markets.

Business and consumer confidence are also contributing factors in which direction and at what speed economies move. These factors were very favourable at the start of the year, but they have lagged with the surprising high inflation, the level of interest rate rise uncertainty, and general but niggling global geo-political events occurring. This all has brought about significant market instability, with most investment assets caught in the volatility.

There is media hype that having higher rates is unfair on households with mortgage debt. But it must be remembered that it is only a third of households in Australia which actually have mortgage debt. In 2020 and 2021, we had the pandemic induced ‘emergency’ record low interest rates, and this clearly spurred on property prices to record levels. We are simply returning to a normal interest rate environment, which is now definitely seeing lower but more normalised property prices.

For investors and savers in the ‘rate’ space, interest rate rises are now offering up better and more viable returns for cash holdings and term deposits, etc. These rates were near zero percent for most of 2020 and 2021! You can now get near 2% for cash, over 3% for TDs, 3-yr government bonds at near 3.5%, and listed bank capital notes grossing at over 5%. These yields are likely to go higher by the end of this year, but what it shows is not all people will be adversely affected by rate rises! Higher rates are pleasing for certain investors.

So, we are in a period of adjustment. The challenging environment in these current times has been having business activity and consumer demand high, and supply chains still chunky. This is what primarily underlines the market volatility in the past six months with there being various forces adding to the sensitivity of rate rises. In saying all this, there is much ridiculousness in watching the day-to-day market volatility that envelops markets and through dramatic media reporting. Traders, not investors, live on the news wires for anything said or rumoured to cause them to immediate jump in and out of markets on a whim or a mere comment! There is little investment conviction with that approach. They live and die by the sword approach!

We may have higher rates for longer than hoped at the start of the rate rises this year. However, as time goes on for the remainder of this year, expectations are that interest rate and inflation uncertainty should diminish to create more market stability.

A long-term outlook is always the best approach to successful investing, which is achieved by acquiring good quality investment assets capable of delivering a combination of returns for investors via cash flow income and price growth returns.

In the short-term, however, we await in anticipation for Labor’s first Federal Budget to be handed down by the new Treasurer, Jim Chalmers, on the 25th October. Let’s hope it contains more good news than bad so that ‘Grim Jim’ can repel his anointed nickname by the media!

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