There have been 6,700 basis points in rate hikes this year - but what's actually changed?

Hans Lee

Livewire Markets

If you added up all of the hikes made by G20 central banks, even including the cuts made by Turkey, Russia, and China, the cumulative total is still 6,700 basis points. Stripping out Argentina, where inflation is through the roof, it still amounts to 3,200 basis points worth of hikes since the beginning of the year. 

But with inflation still stubbornly high, unemployment at record lows, and investor sentiment shaky at best, the question is - what has actually changed?

In this wire, we're going to take a look at the real impact of these rate hikes with the help of Simon Mullumby from State Street Global Advisors and Anthony Kirkham from Western Asset Management. Plus, in the spirit of a forward-looking market, we'll take a look at how you should be positioned given this reality ahead of 2023. 

Simon Mullumby of SSGA and Anthony Kirkham of Western Asset Management. 

What has it meant for my money?

Financial markets are forward-looking, and as a result, so are the prices of those assets. Until we know what effect rising interest rates will really have on the economy, it's hard to know whether central banks made a second big mistake by not correcting the first big mistake in time. 

For now, consumers are feeling down as they look ahead to how those rate hikes will hit their wallets and mortgages. Kirkham says the Reserve Bank's step down to 25 basis point increases in recent months is an acknowledgment from the Bank about the time it will take for the new world order to filter through to the end user.

"The RBA’s recent pivot indicates some recognition that there are lags and that they are wary of stalling the economy," Kirkham says.

But for investors, the ride has been even wilder.

"The RBA is not only adjusting official cash rates higher but is also holding large positions in both government and semi-government bonds due to yield curve control," Mullumby notes. 
"As these bonds mature, the RBA is likely to reduce the money supply in the financial system, adding another dynamic element to a market that central banks flooded with liquidity."

What might happen now?

In short, a lot of next year's story will be dependent on how hellbent central banks will be on getting inflation under control. That is especially true of the Reserve Bank, given its mandate is (officially at least) inflation-centric. And while many economists expect the RBA will pause its run of hikes sometime early next year, Mullumby argues the biggest risk is actually whether their actions are still not enough to bring price rises back to target.

"One potential market risk is softer and gentler tightening will curtail some inflationary pressures but not drive headline inflation back to within the RBA’s explicit 2-3% target band by 2024," Mullumby says. 

"There is a real chance the RBA’s focus shifts from dragging inflation back into the comfort band no matter what the cost, to a reluctance to further increase rates for fear of inflicting too much pain in the housing sector."

Kirkham has a much more sanguine take and thinks Australia will avoid the worst of the global tightening cycle's effects.

"We expect the central banks will ultimately crunch inflation and that a deep recession, in Australia at least, will be avoided," Kirkham says.

Having said all this, a recession is still a very possible scenario throughout other areas of the global economy. Kirkham also says any risk rally resulting from a central bank pivot would be short-lived.

How do you prepare yourself for what's coming?

The response is mixed depending on your view of where and when the RBA will stop hiking as well as the assets you have exposure to. 

For instance, in its 2023 outlook, Morgan Stanley's Australian arm has an underweight rating on the Big Banks due to its negative view of the housing market. Macquarie is similarly bearish, arguing the requirements for a cyclical low on the ASX have still not been met. 

Globally, J.P. Morgan Asset Management's latest release of its long-term capital market assumptions suggests valuations are no longer the risk to global equities they once were. While earnings revisions are still likely to head downward, there are opportunities popping up - particularly in Europe and the UK. 

In the fixed-income space, Mullumby suggests investors focus on liquidity.

"Given the potential for higher yields and continued market volatility in 2023, investors could choose to reduce interest rate duration, maintain (if not add to) spread duration and focus on liquidity," Mullumby says.

If you have exposure in this area of the market, he noted floating rate notes owned by the Big Banks may make sense if the sell-off in yields were to continue.

Kirkham disagrees, arguing duration is actually your friend in this part of the cycle. He also looks to the fixed-income space and argues corporate credit could have a place in portfolios next year.

"We continue to believe that the investment grade corporate space in Australia is a standout due to the type and quality of issuers in our market, all of which are generally able to pass on any inflationary pressure due to their monopolistic and duopolistic positions within their subsectors," he says.


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I'll be in charge of asking the questions to Australia's best strategists, economists, and fixed-income fund managers. If you have questions of your own, flick us an email: content@livewiremarkets.com

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Hans Lee
Content Editor
Livewire Markets

Hans is one of Livewire's content editors. He is the moderator and creator of Signal or Noise. He also helps write the LW-MI Morning Wrap. Previously, he was the market open producer at ausbiz TV and wrote for Bloomberg, Reuters, and The Australian.

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