Interest rates have been in the centre of economic and investment discussions along the year. Countries are now in different stages of their monetary policy and it can potentially cause different outcomes depending on their positioning
Despite the recent increases on the Australian Interest rate, it remains lower than the US carrying implications.
First of all, it is important to understand that the US bonds are considered the safest investment in the entire world, so it works as a type of benchmark for the globe's interest rates. Naturally, in a global pursuit of investment opportunities, it is obvious that if the safest investment option is offering good returns, it will be one of the preferential spots to park investors money and therefore drawing substantial investment inflows.
So, coming back to the situation Down Under, despite its resilient and robust economy, performing relatively well including in crisis periods,if the Australian interest rate lags behind the American rate, if the Australian interest rate lags behind the American rate, a significant portion of investor funds gravitates towards the United States. If we are dealing with intelligent decision makers, it is expected that if we have two opportunities and the safest one is offering better yields, it is a no-brainer, right?
Well, that money running to the US instead of Australia, brings a myriad of consequences to the economy and the markets. While the intricacies are beyond our scope here, let's focus on how this dynamic impacts exchange rates and subsequently affects the economy.
Simplistically put, if money flows are going to the US rather than Australia and furthermore, probably some money is going from Australia to America. Consequently, the US dollar's scarcity elevates its price against the Australian dollar, resulting in AUD depreciation, and it has been actually occurring already.
So, coming back to the beginning of this article, we now face a scenario with a relatively high interest rate (though lower than the US) and a depreciated exchange rate with a downwards prospect.
So what we can expect from this scenario for the economy and stock market:
- High interest rates have the power to discourage investment in stocks, as safer alternatives like Government Bonds offer competitive returns, also an elevated rate can bring pressure to heavily indebted companies, these two factors can drive the stock prices down.
- However a big chunk of the largest public companies in Australia are basic material producers and exporters. The good news is, exporters can benefit from low exchange rates, turning them more competitive, as the costs are lower vis-à-vis international counterparts while boosting revenues in USD dollars brings more AUD dollars home.
- On the other hand, a depressed Ozzy Dollar may trigger inflation, due to increased costs of imported raw materials, food, and other items in the local economy.
Unfortunately, we can't predict the future. I don't have this ability nor I believe it is possible, but, we can go back to the past and check what happens when similar situations happened, as the saying states: history does not necessarily repeats but it often rhymes.
In the recent past, when Australia got lower rates than the United States, around 2000 and again around 2019.
In both periods the AUD dollar weakened compared to USD, even though it was just for a brief term in the latter case.
And also during these periods, the ASX 200, the main benchmark for Australian Stock market got positive results, Notably, in 2019, the Aussie stock market yielded an impressive performance of nearly 21% return.
Well, it is happening again, the interest in Australia is lower than the US rate and furthermore, it is expected that the US Federal Reserve will start cutting rates before the RBA, which can even broaden the disparity.
We can see that the AU dollar is already low and apparently decreasing further. So does it mean that we can expect good results from the S&P ASX 200?
Of course it depends not only on these factors, there are a lot of situations in the world and local economy that also interfere. But what we are able to do is watch closely how the exporters are behaving and if they are taking advantage of the favourable situation. Also, it is valid to mention that as the decline of the Australian exchange rate can probably push the prices up, a close eye on the inflation behaviour is also recommended.
Let's see how it all is going to unfold…
I hope your investments bring you great returns!