While in the US interest rates are increasing, in Australia further rate cuts are likely. Divergent monetary policy has implications for clients’ portfolios. It’s important to educate them now about the potential impact of future interest rate changes on their investments.
The US Federal Reserve raised the target range for federal funds to 0.75 per cent in December 2016. At the time, Federal Open Market Committee chair Janet Yellen indicated US rates should reach 1.4 per cent by the end of the year, 2.1 per cent at the end of 2018 and 2.9 per cent by the end of 2019.
In Australia, however, softening local economic conditions mean the cash rate could continue to fall.
AMP Capital chief economist Shane Oliver says he expects the Reserve Bank of Australia to reduce its 3 per cent economic growth forecast, which will affect its decisions around monetary policy. “We think the RBA will cut rates again [in 2017],” Oliver says.
Executive director of financial advice firm Crystal Wealth, Tim Wedd, says the effect on asset classes from interest rate movements will depend on how quickly rates change and how this marries with market expectations.
“If US rate rises are quicker than expected, say on inflation fears, bond markets may sell off and equities may come under pressure – particularly in listed property, infrastructure and utility sectors,” Wedd says. “Markets should absorb moderate rate rises associated with improving underlying US fundamentals, which should mean a positive environment for growth assets. Companies that can maintain and grow dividends will remain highly valued. Cash and bonds will also start offering better yields.”
Against this backdrop, a senior wealth adviser for Macquarie Wealth Management, Noel Yeates, says the conversation advisers should be having with clients is about looking forward to 2018 and 2019.
“If interest rates are on the up, irrespective of what happens here in the short term, there has to be a lift in the cost of money globally,” Yeates says.
He says a concern is that clients are not considering how higher rates might affect property investments, which are usually underpinned by a mortgage. Borrowing costs rise as interest rates rise, which can reduce real-estate returns.
In contrast, certain asset classes will benefit as interest rates rise, meaning portfolio construction may need to change. This is especially the case when it comes to achieving the right balance between high- and lower-risk investments.
For instance, investors may be content investing in stocks with a dividend yield of 4 per cent now. But as interest rates rise, so will returns from fixed-interest investments such as cash and term deposits. As such, advisers and clients will need to re-assess whether the risks they are taking on in their portfolios are worth the return.
While there are many unknowns in markets, rising rates and hopefully higher economic growth long term are two of the main variables that will continue to occupy planners’ minds this year and into the future.
