After 16 months of interest rate hikes from the Reserve Bank of Australia (RBA), we have arrived at an economic turning point.
In what Philip Lowe, the RBA’s outgoing governor, has termed the “third” or “calibration phase” of Australia’s inflation management strategy, interest rates have paused for two months, potentially three on the day this article is published.
But how, if at all, could this new phase affect investment strategies? In this article, I’ll summarise how the latest RBA changes have affected the markets. While keeping across monetary policy updates is important, currency and the GDP, and focusing on large caps less affected by interest rates, could deliver better returns during this period.
The latest RBA updates
Before winter 2023, the RBA was on its most aggressive tightening cycle of all time by percentage move. However, this all changed on July 4, 2023, when the interest rate “calibration phase” began – more simply, when interest rate hikes were paused. While the pause is a welcome change for many after over a year of tightening, this doesn’t mean inflation is back to normal.
The latest figures show annual inflation is sitting at 6% which is over double the RBA’s target ‘Goldilocks state’ of 2-3%. Wage growth has remained consistent and the unemployment rate is at a five-year low of just 3.7%, but inflation is still affecting everyday Australians.
Achieving the 2-3% inflation target, meaning that interest rates can also be brought down rather than remaining static, is challenging because Australia is so heavily affected by other global markets (like the US) and commodities (like oil). While Lowe claimed that the interest rate pause is a marker of the successful impact of the interest rate hikes, there are other factors at play.
One is that Australia has largely been battling ‘imported inflation’. Headline inflation is now declining in most advanced economies ‘by a little more than expected’. Reflecting this, continuing to increase internal interest rates will not do much to support Australia’s economic growth and stability due to our reliance on overseas markets and trade.
How will the calibration phase affect markets?
What happens next will depend on whether this is a pause in the current tightening cycle, or whether the current tightening cycle has ended. There is not yet any evidence that the latter is the case. In fact, the RBA’s August minutes said: “...members agreed that it was possible that some further tightening of monetary policy might be required to ensure that inflation returns to target in a reasonable timeframe”.
Interest rate movements most heavily affect individuals and small caps with bank loans, and short-term money market rates like the Bank Bill Swap Rate (BBSR).
Bonds are priced off the back of the BBSR with (generally) a higher interest rate for the higher term of the bonds based on a normal yield curve. Corporate bonds are priced as a spread over a similar duration and Government bonds with a premium for the additional risk. As bonds rise in reaction to higher rates, they are becoming a comparable investment to equities on rate, and we may see flows move out of equities and into bonds.
The bigger picture for investors
Building and maintaining a strategic investment plan requires oversight of long-term economics. The global currency market, commodities and their effect on the Australian GDP are elements that, therefore, may have more impact on long-term trends than monthly RBA announcements.
Despite massive socio-economic factors impacting global markets, like the Russia-Ukraine war, trading in global currencies has remained consistent.
Interest rates affect the value of the Australian dollar and this impacts imports and exports, but long-term trade agreements with our major trading partners reduce the impact of currency movements. Australia is also tied heavily with the US market, so watching commodities and global markets can be more insightful than interest rate changes.
There are no safe sectors to invest in but by monitoring the ASX over time, one can also identify which large caps consistently over-perform. For example, critical infrastructure like gas and electricity companies are more sheltered from rate rises, and high dividend companies will give you a return on investment even if share prices plummet.
So, while RBA policy changes may affect investor strategies by encouraging them to include more bonds and fewer small-cap investments in their portfolio, a focus on the bigger picture (currency, commodities and GDP) can always support a forward-thinking investment strategy.
Author Jeffrey Triganza is head of Market Analysis, Vantage Markets.
Disclaimer: This article is not intended as investment advice.
Vantage doesn’t represent that the material provided here is accurate, current or complete, and therefore shouldn’t be relied upon as such. The information provided here, whether from a third party or an employee of - Vantage, isn’t to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product or instrument; or to participate in any particular trading strategy. We advise any readers of this content to seek their own advice. Without the approval of Vantage, reproduction or redistribution of this information isn’t permitted.