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As I See It: April 2023


1.  Interest Rate Decision

The RBA held rates at 3.6% after 10 rate hikes over the last 10 months. The balancing act between lifting interest rates to reduce inflation while now pushing the country into recession is a difficult one.  It needs to be seen in the context of global peers raising rates back to more normal settings as we fully exit the emergency settings caused by the covid epidemic. Using the metaphor of lifting heavier weights in the gym or running faster on the treadmill there is growing financial pressure in the community and really no point in exacerbating the situation merely to drop rates at a later stage this year.

Rising interest rates redirects funds from consumption to meeting higher mortgage payments for consumers. For business it means reallocating resources from employing more staff to again meeting larger interest commitments. The sum of this can become a vicious cycle of price increase from business and wage increases for employees. So, in a way interest rate rises create their own inflationary expectations which is self-defeating above a certain level where demand for capital becomes ‘in-elastic’.

Inflation continues to fall to 6.8% annually with electricity costs followed by travel being the largest contributors who are supply based issues which should decline as economic conditions normalise. The expected trend now is for inflation to continue to fall over the next 12 months which will allow the RBA to commence dropping interest rates. This would then be a positive for both shares and property and would allow current unrealised fixed interest losses to be unwound. Overnight cash rates are now well below the RBA rate indicating that interest rates could begin declining as soon as late 2023. Clearly it would be best to keep rates as stable as possible and allow inflation to stabilise naturally as supply chain issues resolve themselves.

Graph:  Annual Inflation Figures
Source:  ABS, Michael Read

Graph:  Annual Inflation – Selected Items
Source:  ABS, Michael Read

2.  Global Banks

The last few weeks were dominated by the failure of several regional US banks whose assets were sequestrated by the US Government held in trust and then on sold to larger competitors. Importantly the US Government extended the guarantee over deposits from $250k to unlimited balances thus implicitly establishing a precedent to protect all deposits irrespective of how large their account is. Silicon Valley Bank (SVB) was the largest US bank failure since the Global Financial Crises of 2008 and the 16th largest in the US. 

Graph:  US Banks By Asset Size
Source:  Federal Reserve

The speed of withdrawal through online banking means that decisions need to be made very quickly.  The bank’s problems were not around bad debts from customers but a run of funds from wealthy corporate clients and a timing miss match of bonds which had to be liquidated at substantial losses due to higher interest rates to cover the withdraws. To be clear the collapse could have been avoided through matching their liquidity needs properly through actively managing their bond portfolios and better communication with depositors who merely moved their cash to stronger national banks. There were several warning signs including a lower level of supervision due to being subject to State Law and an over exposure to the close-knit Tech Sector in Silicon Valley.  No doubt there will be ramifications including for the CEO who sold shares a few days prior to the collapse.  This was followed by several similar cases in New York where customers were primarily crypto currency eventually bought by stranger competitors.

Over in Europe the weakest of the ‘systemically important banks‘, Credit Suisse which had struggled for many years and seen as the weakest link in any systemic run on the banks was forced via the Swiss Authorities to be sold to UBS. While shareholders received consideration in UBS shares hybrid investors (fixed interest instruments which can convert to equity) were wiped out which has caused significant market concern as to the effective preferential rights of investors in the case of administration or change of ownership.

It does come to the nature of written agreements and in Australia all hybrid investments automatically convert into ordinary equity in a similar circumstance. The natural concern now is the contagion effect and whether any other banks are next In line with Deutsche Bank regarded as the next weakest. Memories of the GFC are still fresh in policy makers minds and at this stage authorities have been quick to ‘triage’ and quarantine any potential problems. Interest rates peaking should help limit any future defaults and it is important to keep this in context with Australian Banks holding far more capital in reserve than at the GFC with most of their lending being to residential mortgages and associated family businesses.

3.  Net New Migration

Australia will experience the biggest two-year population surge in its history with an extra 650,000 migrants this financial year and next driving a 900,000 jump in the number of residents. This should be a real positive for the country increasing tax revenue and demand for our goods and services including housing. This is a catch up from the three lost years to Covid and effectively increases the population by 3% which should have a knock-on effect on business activity and entrepreneurship.

As we all know, Australia is a great country to live in and very desirable to potential migrants and providing there are the right safeguards in place strong migration should translate into prosperity for the country. Our population growth is in stark contrast to most of Europe which is effectively declining and makes us a better investment option for global fund managers.

Graph:  Net Overseas Migration
Source:  ABS, Treasury

4.  Housing Shortages

The current slump in the building sector due to uncertainty on costs and higher interest rates is leading to a lack of supply which will be exacerbated as the population grows.  Rents have increased substantially which have also been a major cause of inflation, although Covid did keep some inner-city rents artificially low. The supply/demand balance will sort itself out over the next few years as building costs stabilise and development become economically viable. 

The build to rent sector is expected to grow rapidly supported by both State and Federal Government initiatives. At this stage, the cyclical declines in property prices in the major cities have abated with most properties still significantly higher than pre Covid and we may see improvements in valuations moving forward.  There are some March figures from Corelogic showing Sydney house prices up 1% this month.

We are doing a lot of refinancing as mortgages come off fixed rates.  Please contact haydn.dale@virtueandpartners.com.au for assistance as needed.

5.  Internal – Budget in May

The next major economic event will be the Federal Budget in early May.  We will have full commentary in the next newsletter including any changes to Superannuation that may be announced.  It would be prudent where possible to make super contributions over the next few weeks in case any further changes are made to contribution and maximum account balance rules. There will be plenty of detailed commentary on our website www.virtueandpartners.com

As always we thank you for your support and referrals and are here to help you navigate the financial issues of life.


Tony and Fiona

Posted by Dr Tony Virtue, Principal


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