Hills to Hawkesbury Living Magazine - - In The Issue - Clif­ford Gadd

In Fe­bru­ary 1990, the Re­serve Bank of Aus­tralia (RBA) de­cided to lower the of­fi­cial cash rate from 17.5% to 17.0%. Had you at that point called for pro­jec­tions as to when the rate would dip be­low 2%, more than likely the most pop­u­lar call would have been ‘never’.

It took a while, but ‘never’ ar­rived in May of this year, when the cash rate was low­ered by 0.25% to 1.75%. It has since been low­ered a fur­ther 0.25%, cur­rently stand­ing at 1.50%.

Let’s re­visit our de­lib­er­a­tions of early 1990 and this time ask our­selves when might the cash rate re­turn to the 17% area. Per­haps ‘never’ might not seem quite as im­plau­si­ble.

Not­with­stand­ing the in­ter­est value of th­ese types of dis­cus­sions, their prac­ti­cal value lies in the fact that they re­mind us as in­vestors, bor­row­ers, lenders and savers to be aware of a key fact: de­spite an overt ap­pear­ance of sta­bil­ity, things do change over time.

Per­haps we have reached a turn­ing point in what has been an ex­tended down­ward trend in in­ter­est rates, with a re­newed up­swing emerg­ing. In my opin­ion this is in­deed the case. Three key data points lead me to this view.

First, eco­nomic ac­tiv­ity in the US is clearly on an up­ward path. More­over, the sus­tain­abil­ity of this growth is be­com­ing more as­sured. US Com­merce Depart­ment data shows that, over the three months to Septem­ber, the US econ­omy grew at an an­nu­alised rate of 3.2%, ad­justed for in­fla­tion.

The chart above (a) puts this into his­tor­i­cal con­text, clearly il­lus­trat­ing the pace of the cur­rent ex­pan­sion in the US econ­omy and the ex­tent of its re­bound from the GFC-in­duced depths of 2009.

Sec­ond, US house­hold spend­ing, by far the largest sin­gle com­po­nent of the US econ­omy, grew at an an­nu­alised rate of 2.8%, well ahead of ear­lier es­ti­mates closer to 2%. Fur­ther­more, US shop­pers ap­pear likely to carry on spend­ing into the year-end hol­i­day shop­ping sea­son with the Con­fer­ence Board’s for­ward-look­ing in­dex of con­sumer con­fi­dence ris­ing to a nine-year high in Oc­to­ber. Fur­ther in­dica­tive of US con­sumers’ op­ti­mism is the fact that, com­pared to last year, on­line sales jumped 17% on Black Fri­day, the day af­ter the Thanks­giv­ing hol­i­day and a key US shop­ping day.

Third, the US labour market is strength­en­ing, pro­vid­ing a sound un­der­pin­ning for con­sumers’ op­ti­mism. Non-farm pay­rolls grew by more than 145,000 in Novem­ber, ad­mit­tedly not quite up to market ex­pec­ta­tions, but nev­er­the­less suf­fi­cient to lower the un­em­ploy­ment rate to 4.6% from 4.9% pre­vi­ously.

The chart above (b) shows steady progress made in US job cre­ation since the re­ces­sion­ary pe­riod of 2008-09. Sig­nif­i­cantly, it shows that, at sub-5%, un­em­ploy­ment has re­turned to lev­els that pre­vailed dur­ing the pre­vi­ous ex­pan­sion.

In ag­gre­gate, th­ese data points sug­gest that US eco­nomic ac­tiv­ity has strength­ened to an ex­tent that is con­sis­tent with the re­cent rise in US bond yields. More­over, the up­ward trend in yields should con­tinue as the in­fla­tion­ary im­pact of ca­pac­ity con­straints even­tu­ally makes its im­pact felt. US of­fi­cial in­ter­est rates must rise to re­flect and in­deed pre-empt this new re­al­ity. An in­crease ap­pears all but cer­tain this month.

Higher US in­ter­est rates nec­es­sar­ily im­ply a cor­re­spond­ing move­ment here in Aus­tralia. The im­por­tance of this can­not be over­stated.

For in­vestors, the early stages of a ris­ing in­ter­est rate en­vi­ron­ment present a unique challenge and in­vest­ment op­por­tu­nity. By po­si­tion­ing them­selves in com­pa­nies whose op­er­a­tions are sen­si­tive to the im­pact of the eco­nomic cy­cle, and have strong pric­ing power, in­vestors can po­ten­tially ben­e­fit within an en­vi­ron­ment that is typ­i­cally char­ac­terised by a strong up­lift in earn­ings and prof­itabil­ity.

Clif­ford Gadd is a writer for The Word Ge­nie. Gail Gadd is an Au­tho­rised Rep­re­sen­ta­tive of Life­span Fi­nan­cial Plan­ning and has an in­ter­est in The Word Ge­nie. The views ex­pressed here are those of the au­thor.

Source: Fed­eral Re­serve Bank of St Louis



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