How to Deal with A Rising Interest Rate Environment
With each passing day, the rumblings around interest rate rises continue to grow louder.
With the latest CPI data from Australia showing that inflation is now sitting at 3.5%, the calls keep coming for the RBA to act sooner rather than later on interest rates. We’re also hearing a similar story out of the US where their headline inflation just topped 7%, which is the highest since June of 1982.
For investors, the obvious question to ask is how do we deal with an environment where rates are set to rise after having been at the lowest level in recorded history?
At this stage, we’re seeing many lenders already moving early on their fixed rate products, especially over the last two months. Across the board, five-year fixed rates are still well below 4% with most banks, depending on factors such as whether the loans are for investment or owner occupier purposes and Interest Only or Principal and interest.
If we look at that rate in the context of history or even from pre-COVID times, that is still a very reasonable interest rate to be paying. Even if the RBA increased the cash rate to 2% over the course of the next year, this is still incredibly low by historical standards. The upshot of this is that variable interest rates will begin to rise with the OCR and variable rates may again rise well above some of the fixed rates that are still on offer now.
The other consideration for investors is that even the outlook of rising rates can cause equity markets to soften. When people have less money sitting in their super funds, even though they can’t access it, it still makes them feel a little bit worse off. And this has the impact of weighing on sentiment then, in turn, feeds through to consumer spending behaviour and impacts the economy as a whole.
The good news for property markets is that in recent times, many astute homebuyers and investors have taken the opportunity of record-low fixed interest rates and locked in some of their mortgages or investment loans for between 2- and 5-year periods.
Many lenders have seen that approximately 50% of new loans taken out over the past 12 months have been at fixed rates and accounts for around 30% of total outstanding housing debt. This should provide a further cushion for households when interest rates begin to rise, and the impact of higher variable rates is going to be softened considerably for a period of time.
It is worth bearing in mind that this is also from the segment of the market that has paid some of the highest prices on record for property in almost every state of Australia over the same period.
Many people should also have a further built-in buffer in place through additional mortgage payments they have been making, by saving the money they’ve not been able to spend on things like travel and other discretionary expenditures over the past two years due to pandemic restrictions.
With falling unemployment and rising inflation, the RBA and FOMC will ultimately start the process of lifting interest rates. Just how fast they do this, will be the real question, although I think that markets may be underpricing the terminal rate during this tightening cycle and perhaps the duration as well.
The other consideration is that this time around they likely won’t have the luxury of going down the path of maintaining easy monetary policy and going back to their tried and tested tricks of printing money and slashing rates as we are already at that point.
Fortunately, many property investors should have a degree of insulation to rate rises in the coming years and even now it’s still not too late to lock in a fixed rate if you think that might give you a degree of comfort for the foreseeable future.
We would also expect the FOMC to outpace the RBA with their rate rises, which will put downward pressure on the Aussie Dollar and ease the burden for many Australian expats who are earning their income overseas.
We’re in an unusual period of time, where we are seeing a falling jobless rate and rising prices, brought about by supply shortages and labour shortages caused by closed borders, people leaving their jobs and the ongoing supply chain issues that may persist for some time. With the RBA due to meet next week, there is plenty of interest in what Governor Lowe has to say, to see how he intends to address all of these issues.
Property markets around Australia are going to be impacted quite differently depending on their location and how the key underlying drivers of housing prices will unfold over the course of 2022 in the various States. The upcoming federal election outcome and the incumbent government assistance in bringing in a substantial amount of labour from overseas will also be a key factor to consider when looking at potential housing demand in various regions across Australia. All these factors mean that it would be very prudent to closely monitor an even greater array of data than over the past two years, and we look forward to sharing our thoughts over 2022.