Three elements to watch with higher interest rates in Australia

The RBA ripped off the interest rates band-aid for the second time in over a decade, rising the official interest rate by 0.5% yesterday (vs market expecting a hike of 0.25%). This takes the cash rate to 0.85%. The RBA decision was more aggressive than most thought; so it spooked the Australian share market; punishing stocks that traditionally suffer in higher interest rate environments; which is why the Australian Technology sector fell back down to two-year lows, and now collectively is 42% lower than its peak, the Consumer Discretionary sector fell to two-year-lows and is now down 24% from its high, while the Australian Property sector fell slumped to a new year-low, and is down 21% in total from its November high.

The bottom line is, the market (or consensus) estimates, will probably continue to get rate predictions wrong, which will cause more volatility. So to get ahead, consider devising a simple checklist (or use ours below) of why we think the RBA will likely rise rates more aggressively. Secondly, consider looking at or investing in those potentially winning sectors, and maybe consider your exposure to those sectors that will likely continue to slide lower as rates continue to spike in 2022 (given the Australian economy is strong enough to stand on its own) .

Rate hike checklist

Consider what the RBA will be looking at month-on-month, ahead of their next meetings, so you can get ahead of the curve. Take yesterday’s RBA interest rate decision meeting for example; we knew they would have factored in the following;

• Consumer facing inflation is rising and could likely continue, fueled by raw prices rising. Month on month, compared to the last RBA meeting to yesterday’s they would have observed; the oil price had risen 15%, pressuring petrol prices up. Gas prices rose 28%, pressuring up power bills. The wheat price gained 5%, hurting food prices. (Separate to that, the RBA would have observed the Australian dollar gained 4%.) All of these price measures are reflected upon at bank meets and are expected to push up for the rest of 2022. Excluding that, Australia’s Energy Regular thinks utility prices could rise up to 14% this year from July. All this supports our view of higher for longer inflation, which means you could expect the RBA to be more hawkish at next month’s meeting and so on. For more on price inflation refer to our quarterly outlook and daily commentary.

• The RBA looks at economic indicators- which are strengthening. Better than expected economic news gives the RBA ammunition to rise rates. Of late a triple whammy of greater than expected economic news has been released. Recall Australia’s economy grew stronger than expected in Q1, Australia produced record Australian export income, and Labor’s childcare policy was pledged - which will see mums and dads return to the workforce (adding to the already full-employment picture, which will add to wage pressure- .i.e. wage price inflation).

The icing on the cake will come from, Australia’s biggest commodity consumer, China, coming out of lockdown. A big first step was when Shanghai, China’s most populated city and its business hub, came out of two-month lockdown last week (June 1). This caused key commodity prices to rise to fresh highs (oil, iron ore, copper for example).  The next question is, as commodity demand grows again, will it put pressure on commodity prices? We think so. This means Australian export income will likely rise to another record high, and the AUD will likely be supported. Also consider if China reopens later this year, our services sector (which adds 70% to GDP) will likely get a boost. This breeds better economic fire power and gives the RBA yet more ammunition to rise rates. For weekly updates on China click here, or follow our daily commentary.

Potential winners of higher rates?

When it comes to investing with higher rates and yields in mind, it will likely pay to be invested in those companies that are beneficiaries and or contributors to inflation; energy, mining, and agriculture securities. In addition to that, as rates rise, yields rise, so insurance companies will likely be supported higher as well. Insurance companies for example, like Suncorp, QBE and IAG for instance could potentially see their profits rise by 20% if rates rise in line with consensus (up to 3% this year).

Potential losers of higher rates

On the downside, as highlighted above, tech, property, consumer spending stocks will likely continue to face selling pressure as rates rise more than expected. And in this brand new cycle, banks will likely continue to fall too. Why? Well despite, record high employment, consumers are faced with record inflation. Consumers also have to cop higher interest rates, at a time when they’re borrowing and saving less. Property lending has fallen, household savings are dropping and Australia’s property boom will end. Banks are already facing margin (profit) compression, and now they face bad debts increasing, delinquency rates rising and losing more lending business as householders are forced to reluctantly sell their homes. This will add further pressure to property prices falling