Interest rates can convey the health of a country’s economy. Lower interest rates can help promote borrowing and therefore stimulate an economy which is struggling. The downside is that lower rates can stoke the fire of inflation. When the economy is doing well, central banks will raise rates to take a bit of heat out of the system. A hike in interest rates therefore means that the economy is doing well. The Australian cash rate has been on hold since August 2016. However in the US, the Federal Reserve have hiked the US rate 7 times in the same period. The Australian economy is still sluggish whereas the US economy is strengthening. What effect does a rising US rate have on Australians when the RBA is yet to raise the local cash rate?
Lowers the Australian Dollar
The US rate hike will keep the Australian dollar down. This is because higher US interest rates offer investors a better return on their dollar. Because of this, investors will buy the US dollar, which will lead to increased demand of that currency. This will lower the value of the Australian dollar. This can be beneficial to our economy as it means Australian exports can be more competitive. It also makes travel cheaper for overseas visitors. As the mining investment continues to unwind and the housing construction cycle peaks, it is important for Australia export remain competitive.
A higher Australian dollar will be detrimental to companies that have borrowed in US dollars. They will need to exchange more local currency to pay into American dollars.
Commodities are priced in US dollars which means bigger profits for these companies as the US dollar strengthens. Higher commodities prices will help increase the share prices of the companies producing with these commodities.
Impact of Australian Banks
Australia’s household savings rate is now a decade low of 2.1%. Bank loans exceed the total deposit so Australian banks needs to source their funding overseas.
Long term fixed mortgage rates have a correlation to US bond yields. As bond yields have been increasing, banks have had to increase the rates on fixed term home loans. The wholesale cost of funding is going up for the banks and they are passing it onto the consumers.
The variable rates on home loans are linked to the Bank Bill Swap Rate (BBSW rate). This is the rate banks lend to each other for a three-month period – and it is also increasing. Banks are finding their short-term borrowing costs rising as banks source their funds from overseas markets. The RBA has left the official cash rate on hold for 20 months in a row now but banks have been absorbed these increased lending costs. This is due to a fear of bad publicity in wake of the banking royal commission. However, the shrinking net interest margins have been putting pressure on banks and lately they have been hiking variable and fixed rate mortgages. This is even though the official cash rate has not increased.
Companies which generate revenue in USD will be positively affected by a raise in the US interest rates. These companies will benefit from a strong US currency as they will make currency gains when profits made in USD are converted back into AUD.
Lowering Gold Prices
Gold prices usually moves inversely with interest rate hikes and news of further US interest rate hikes has been negative for this commodity. Gold tends to be a safe haven that investors use when the economy is not doing well. If the economy is strong, investors will rotate out of gold and put their money in higher yielding investments.
Higher interest rates usually cause bond prices to lower as bond yields increase. This is bad news for existing bond holders as the price of their bonds will fall. The rise in the US fed rates will decrease the demand for bond.
Lauren Hua is a private client adviser at Fairmont Equities.
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