Interest rates up – and down
From Tony Alexander
The Reserve Bank has raised its official cash rate by 0.5% three times in a row now and extra rises eventually taking the official cash rate to 3.5% from the current 2.5% look likely. But the most recent change in fixed mortgage rates has been a cutting of the two year rate charged by most lenders. How can rates go down when monetary policy is tightening?
The Reserve Bank’s official cash rate mainly affects floating interest rate costs facing banks and changes tend to cause near immediate shifts in floating mortgage rates. But as we move to progressively longer term fixed rates the cost to banks of borrowing that fixed rate money in the wholesale markets more and more reflects expectations of where the cash rate will sit – not where it sits at the moment.
The key development here and especially offshore recently has been an extra surge in inflation causing central banks to accelerate their monetary policy tightening. The view has developed that these banks may have to push their economies into recession in order to suppress inflation. Recession means an eventual decline in interest rates and that is what investors are increasingly focussing on.
Expectations are high for instance that US monetary policy will ease in the second half of 2023 and a similar expectation is starting to be priced in here as well. The upshot is that bank funding costs for lending at fixed rates for two years and longer have fallen on the back of heightened recession risk.
For borrowers the message is that fixing longer than two years may be unwise for many because these rates are close to their cyclical highs. There is a world of difference for instance between fixing one’s rate for five years now at close to 6% and fixing it at 2.99% in the first half of 2021.
For most borrowers riding the cycle up then down with a focus on the one and two year rates is probably optimal.
For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz
Share markets are volatile. That means they experience dramatic rises and falls which impact on the value of investors wealth. Property and bond markets are also volatile, however, typically less so and not as dramatic. When bad news about markets and economies hit the airwaves, instead of sticking to their long-term plans, investors behave irrationally. Who can blame them though? It’s difficult to look at the value of your wealth drop significantly in a short space of time. How significantly are we talking?
Well, let’s look back through a century of recessions, reviewing the biggest market corrections following a recession. The graphic below represents the US Market index overtime. The line represents the cumulative value of $100 overtime. The green shaded areas represent recessions overtime.
The greatest drop in the US share market value following a recession occurred during the great depression. The US market index dropped 83.6% from its previous peak in 1929. The market downturn lasted 33 months. Investments made in 1929 would take until the 1940s to recoup their losses. That’s because investors were hit with another recession in 1937. The market downturn lasted 12 months and dropped 49.2% from its peak in 1937. We have not experienced an economic retraction or market downturn like this period since.
The second biggest drop came during the global financial crisis in 2007. The US market index dropped 50.4% from its peak. The recession lasted 18 months and the market downturn lasted 16 months. Investments made in 2007 had to wait until 2014 to recoup their losses.
The third biggest drop in the US Markets came during the Oil crisis where inflation hit double digits. The US markets dropped 46.4% from its peak in 1973. The market downturn lasted 21 months. Investments made in 1973 had largely regained the losses by 1975.
The fourth largest drop in the US Markets occurred over 1969 to 1970. High inflation and a big jump in unemployment punctuated the 11-month recession. The US Market index dropped 33.6% from its peak. The market downturn lasted 19 months and experienced a lot of volatility. It had recovered and gained by the end of 1971.
The fifth largest drop in the US Markets occurred at the Tech Boom and Bust from January 2000 to September 2002. The US market index fell 33.2% from its peak. The market downturn lasted 13 months. The market had regained its losses by 2007.
From 1926 to the end of 2021 the value of $100 grew to $1,156,523. I was sent a video from a client that brings some humour to that statement. You can watch this financial advice here: https://youtube.com/shorts/f4eJhRz0uhE?feature=share
Hopefully this article highlights a few key things for you about investing:
- The current market behaviour is normal
- Investment markets move up and down (across shares, property, bonds and alternative assets)
- Diversification is critical. During the recessions some companies will have been forced to close and shareholders will have lost money on investments made into those companies. Some people will have lost money on properties (if they were in a position where they had to sell). Having small investments in many assets across different classes (property, shares, bonds, cash) means that companies falling over has a minimal impact on your portfolio.
Also, the tech bubble impacted the US market index more than the New Zealand market which continued to make gains. So, diversification across countries is also important.
- Time in the market, rather than trying to time the market is more important. However, the sooner you start the better off you’ll be. You are rewarded for your discipline and patience.
- Stock returns represented by Fama/French Total US market Research Index available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
- Graphic and data supplied by Dimensional Fund Advisors
Disclaimer: This newsletter is meant to be informative and engaging, hopefully not a cure for insomnia. Please don’t take this as personalised financial advice. Discuss your situation with an Advisor. This is where I need to say past returns are no guarantee of future returns.
- Posted by Isbister
- On July 15, 2022