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Have interest rates bottomed?

11 May 2015  |  Economics

BottomAustralia's cash rate is now 2%, which is creating a number of issues for SMSF investors, especially those who are, well, mainly in cash. After taking into account inflation and fees, erm deposits are now providing negative returns for most DIY investors. The hunt for yield is on.

But is the cycle about to turn. The AFR suggests that trends in the US indicate that the big driver of low global rates, virtually zero interest rates on US Treasury bonds, is about to turn:

 

"A little appreciated fact is that Australia's three- and 10-year government bond yields, which are the market's best guess as to where the cash rate will be on average over those periods, are more than 90 per cent correlated with equivalent US rates. This is true in other economies too. 

Mercedes

So why were US yields rising? It turns out that a heterodox case I have repeatedly posited here – whereby the popular and financially convenient "low rates for long" meme is junked by budding US wage pressures spooking bond bandits – has finally arrived. The issue overlooked by most investors is that the 5.5 per cent jobless rate in the US is not far above the cyclical troughs attained before the 2001 "tech wreck" and the 2008 global financial crisis. In both episodes equities were crushed by 50 per cent or more. More significantly, the never-before-seen zero interest rate policy maintained by the Federal Reserve more than four years after gross domestic product growth in the US returned to positive territory has forced the jobless rate through a crucial threshold below which wage pressures tend to materialise.

In 2014 the Fed's current chair, Janet Yellen, revealed her own estimate of this so-called "non-accelerating inflation rate of unemployment" (NAIRU). "The unemployment rate consistent with maximum sustainable employment is now between 5.2 per cent and 5.6 per cent," she said.

Based on Yellen's analysis, we are close to technical full employment, which is awkwardly juxtaposed against the cheapest money in human history."

 

This puts Australia somewhere wedged between a recovering US and a slowing China. The China boom has helped us stave off the effects of the collapse in America. It is no longer the case that 'when the US economy sneezes the Australian economy catches a cold.' But now we are catching a cold from China, as evidenced in the deterioration of the Federal Budget because of slowing tax revenue.

It is a difficult set of cross currents to read, but it does seem likely that interest rates may be near their bottom.

 

 

 

 

 

Mercedes


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