Trilogy (in Ancient Greece): a series of three tragedies performed one after the other
If you have been following the key financial news in 2022, we hope you drank your morning coffee first. There has been no shortage of unnerving headlines that could have you spilling your (now) $7, extra hot macadamia nut latte before your first sip.
The headlines: Surging inflation, falling real wages and the rapidly encroaching interest rate hikes. A trilogy of economic impacts that are already playing out in markets and setting the scene for more volatility ahead. But there is some good news amidst the carnage for the sophisticated investor… read on to find out more.
Hint: Starts with “Structured” and ends with “Investments”.
Consumer Price Index (CPI) Rises to 5.1%
For those who are unfamiliar, the CPI measures the changes in price of a fixed basket of goods and services, purchased by households. CPI rises are most noticeable when fuel and grocery prices increase or when you go to buy your (now) $7 extra hot macadamia nut latte in the morning. It is the most comprehensive and leading indicator of inflation and in March 2022, the Australian CPI rate rose to 5.1% p.a., recording its largest annual (and quarterly) rate rise since GST was introduced in 2000. This annual CPI print exceeded market and economists estimates who had forecast in Q4 2021 that it wouldn’t be more than 4.6%. The print was also a good 2% above the upper limit of the target inflation band that the RBA views as supportive for sustainable economic growth.
Today, 3 May 2022, the RBA Board is coming together for their Undecennial (11 Annual) ‘ Monetary Policy Decision’ meeting. Economists widely expect that this meeting will see the cash rate increased by 0.15%. While RBA’s Governor, Philip Lowe, famously took a dovish stance in November 2021 announcing that it was “ entirely possible that the cash rate will remain at its current level until 2024”, economists warn that this is no longer, “entirely possible” because the inflation genie is now well and truly out of the bottle and the ‘data’ says they have to move.
With the Federal Election only weeks away, a rate hike would be politically controversial as voters are forewarned that the current and historically low, 0.1% interest rate, will soon be a vestige of the past. In fact, it is likely that today’s RBAs announcement will set the Australian economy on a path for consecutive interest rate increases over the next 11 months, ending the 11 year period of accommodative monetary policy. Of course, in the name of democracy, today’s decision is also being viewed as a test of the true independence of the RBA.
Why Rising Interest Rates?
As international markets around the world continue to feel the reverberations of the pandemic, and the war in Ukraine enters its 10th week, we are reminded that global financial markets and geo-political events are unequivocally intertwined. Fragmented supply chains and economic sanctions have the world’s energy and food prices soaring, and when energy prices rise, so does everything else.
Within the current international and domestic landscape, inflation does not appear to have an expiration date, thus the RBA cash rate will need to give.
Raising interest rates is a monetary policy tool used by central banks to contain the rate of inflation. To put it simply, by increasing interest rates, the cost to borrow rises and capital becomes more expensive. In turn, companies face higher loan costs and consumers benefit from better savings rates, thus the demand for goods and services falls. As a consequence, the rate of inflation begins to fall, easing the cost pressures being measured by the CPI.
While tightening monetary policy is a helpful way to curb inflation over time, households are already feeling the pressure of higher prices across all aspects of their costs of living. When interest rates rise in response to inflation, it leads to the same households getting further squeezed as the cost of their mortgages goes up (if they haven’t fixed their home loans) and with it, their monthly repayments. Read this article from the ABC about “ Australia’s real economic Achilles heel: household debt “.
Around half a trillion dollars was advanced by Australian lenders during the pandemic, increasing household debt to record levels. See graph below. This means that interest rate hikes will have a palpable impact on the household budget because, as servicing costs of the debt burden increase, household incomes are squeezed even more.
Falling Real Wages
Alas, the final tragedy that completes the trilogy: falling real wages.
As inflation persists, prices continue to rise for goods and services which leads to an erosion of the purchasing power of the household budget. This is because household income is not increasing at the same rate as inflation. Why? Because there has been little in the way of any meaningful wage rises across the broader economy over the past decade. Without workers receiving pay increases in line with the rate of inflation, the impact is real wages fall — put simply, the household income doesn’t go as far. Household budgets are getting squeezed not only by higher prices, but also by the impending impact of higher interest rates which further compounds decisions around discretionary purchases — like whether you will buy that $7, extra hot macadamia nut latte.
The Good News
Tragedy + time = comedy
Amidst the Trilogy of economic events and outcomes, there is a silver lining for sophisticated investors: Structured Investments.
Structured investments tend to thrive in periods of higher volatility and higher interest rates as investors can be more opportunistic with better pricing and deeper defensive barriers. Stropro offers a number of curated products which capitalise on the changing economic and financial market conditions, including rising interest rates. As funding costs go up, the coupons produced by most income linked structured investments do too.
Stropro provides an array of curated investment opportunities which leverage this unique trilogy of circumstances. For more information about the structured investment products available on the Stropro platform, register here or reach out to our team at email@example.com
Written by Holly Brooks
This article has been prepared by Holly Brooks. Holly Brooks is an Analyst at Stropro Operations Pty Ltd (ABN 28 633 603 399) (Stropro). This article is for educational purposes and is not a substitute for professional and tailored financial advice. This article expresses the views of the author(s) at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views. This article uses information from sources the author considers to be reliable but does not represent that such information is accurate or complete, or that it should be relied upon. Past performance is not a reliable indicator of future performance. Investments may rise and fall in value and returns cannot be guaranteed. Stropro makes no representations or warranties, express or implied, as to the accuracy or completeness of the information it provides. Stropro Operations Pty Ltd (ABN 28 633 603 399) is a Corporate Authorised Representative (CAR №1293257) of Stropro Compliance Pty Ltd (ABN 74 640 214 740, AFSL №533443).