With the RBA pausing rates today as we expected, our base case remains that we have likely seen the peak of the interest rate cycle. The futures market is pricing in a rate cut in early 2024. We think that a cut is coming earlier, at some point in Q3 or Q4 this year, as we believe inflation is going to fall faster than most people think. It’s interesting to see how quickly most mainstream economists have flipped their views from last month to this month. At the time of writing, 11 economists surveyed by Bloomberg News think we’ll see another rate rise, while 16 think there will be a pause. As we have been saying, a rate pause is the most sensible course of action. There are a few reasons for this.
Increased interest rates have triggered the recent collapses of the Silicon Valley Bank and Signature Bank. These were the second and third largest bank failures in the history of the US, eclipsed only by the collapse of Washington Mutual in 2008 during the GFC. European rival UBS has also taken over Credit Suisse as it failed. These bank failures significantly impact global financial markets and institutions, leading to decreased liquidity and increased funding costs for banks worldwide – including Australia. Increased funding costs get passed through to households as a de facto increase in interest rates. The reduced lending effectively acts as another interest rate rise.
Additionally, there is also the looming potential for further pain in US regional banks, which are overexposed to the commercial property sector. Working from home for at least part of the time is the new norm, although many corporations are still stuck paying the leases for partially empty offices. Many of these will not be renewed as corporations seek smaller or more flexible office spaces weakening the demand and value of office spaces. While the banking sector looks stronger compared to the GFC due to the regulations put in place, sharp interest rate rises by the Fed have always ended with something breaking in the economy. If things aren’t already broken, these recent bank collapses indicate cracks forming around the edges. The answer to this has always been to turn on the money printers and rapidly drop rates. I don’t know if the US Federal Reserve is quite at that point yet, but it can’t be far away.
In addition, the ABS’s official inflation figures for February show further confirmation of a downtrend falling to 6.8%, from 7.4% in January from the peak of 8.4% in December. For now, it looks like the first condition of falling inflation has been met, along with a pause in the hiking cycle. We’re keeping a close eye on the unemployment rate, which also looks to have also found a floor. We will likely see this rise throughout the year as the economy softens. As we have said previously, the unemployment rate is usually the last domino to fall in the economic cycle, and what has followed with 100% certainty in the past are rate cuts. Rate cuts by the RBA precede sharp increases in AUD-denominated risk assets such as property and shares. Of course, there’s no way of knowing if this will play out perfectly again, but it’s a good bet if history is any clue.
In any case, the property market appears to be front-running the RBA’s decisions, with the prices appearing to have bottomed out around September 2022. Interestingly there now seems to be a high degree of correlation between the property and share markets, with both having bottomed out simultaneously. Nationally CoreLogic has found prices to have risen by 0.6% in the first month-on-month rise since April 2022. Sydney led the way down and is now leading the way back up, gaining 1.4% last month. Melbourne (0.6%), Brisbane (0.1%), and Perth (0.5%) also saw rises. The rolling three-month averages are also all showing strong signs of a reversal.
Despite all this chatter, when we zoom out and remind ourselves of our investment time horizon, our overall investment thesis hasn’t changed. While there may be stories and narratives along the way, the 18-year cycle remains intact. Most of the East Coast markets and Perth will almost invariably continue to run upwards, with the bull market peaking somewhere between 2026 and 2029.
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