What's going to stop interest rates from rising?
In my monthly prediction pieces published on the Wealthi Research journal, I wrote last month that“The newspapers will continue to print scary headlines, the RBA will keep moving rates higher (because they are hopeless at predicting the future) and in a few months economic growth will slow down.”
This month’s interest rate rises are no surprise. The extent of the increase is probably higher than what I would have expected, but rates have to go up because they are at record low levels. Let’s never forget that.
My focus in these coming months isn’t on the past. It’s not on our accuracy at predicting these things, or reasons for why certain things happened. It’s about the future.
Interest rates are rising, not just in Australia but across the developed world, because there are some huge cost pressures. We’re seeing it in our daily grocery bills each time we go to the supermarket. Tomatoes, cucumbers, lettuce…the list of scary price rises goes on and on.
In the building game its the same thing. Concrete, steel, timber, wages. Everything is going up. But for how long and how will rising interest rates stop this?
There’s one quick indicator that will help you forecast rate rises
I like looking for simple indicators, shortcuts that allow me to live my life and not worry about spending hours following charts or reading the news. In fact, I rarely read newspapers because they contain yesterday’s news…not what happens tomorrow.
There’s one simple indicator that I keep my eye on for all things investment - stocks, crypto, real estate, interest rates, car prices etc. That’s the price of oil. One of the big untold stories in the mainstream media is the huge shock to energy markets due to the current war in Europe.
We’re seeing oil prices that we haven’t seen for some time and that isn’t just hitting us at the petrol station each time we fill up, but also hitting almost every single consumer good and service around the world.
If there’s one chart I want you to remember, its this one below.
I’ve compared oil prices (brent crude) with Australian 2 year interest rates. Most Aussie mortgages are fixed for 2 years or thereabouts, so this is a good indicator of where official interest rates are trading in the market.
The point is that over the past 5 years, Australian interest rates have tracked the price of oil. For rate rises to stop, we need to see the price of oil stop rising. When oil prices rise, global inflation does too and central banks like the RBA need to raise rates to slow things down.
Unfortunately we still live in a world that is dominated by fossil fuels and oil product inputs across the entire food chain. The farmer who grows lettuce will use fertiliser that is often linked to the oil price, plastic wrapping that is made from oil and transportation in a truck to the local Woolies shopping centre via a diesel powered engine.
Oil is everything.
I think we’re close to the point where oil prices stop rising. I don’t know if they will fall, but each $1 rise in oil prices hurts global demand immensely. It's a very complicated and often political calculation, so I don’t intend to go into that conversation here. But oil prices can’t just keep rising forever because the global economy will shut down and send oil demand falling again, like we have seen many times in recent history.
Keep an eye on oil, it will tell you all the secrets about future interest rate rises.
What this means for the real estate market
The bad news is interest rates are rising, which means borrowing costs are higher. The good news is interest rates are rising because the economy is strong. Unemployment is at record low levels, people have jobs and that is a huge positive.
We’re seeing the Australian residential property market shift from a sellers market to a buyers market. In fact I’ll go one step further and say that we are seeing the market shift from an owner occupied market to an investor’s market. Investors who have solid jobs and cash saved up can now come into the market and find better deals.
Most east coast markets in the $400-850k price range have rents that cover outgoings. Even if interest rates rise more and investors are out of pocket through their investments, we have a very generous tax system in Australia that allows for negative gearing.
I think we’ll continue to see a soft market for the rest of the year but the long term fundamentals for Australian real estate are among the best in the world. We have a huge que of immigrants who want to come here and bring their families with them.
We have a very strong economy, a new government which is restoring relations with our trading peers and a strong banking system that can adjust if rate rises become too problematic.
Keep an eye on oil prices and remember for the investors out there, market pullbacks are an opportunity to buy good long term assets on strong fundamentals. My top cities remain Sydney (inner), Melbourne (metro), Canberra and certain parts of Perth (lifestyle shift).
