Interest rates are the price of money and much of the time the movements in financial markets simply reflect changing expectations of future interest rates.
Central banks manage interest rates to maintain favourable economic environments, which includes keeping a lid on inflation. Policy mistakes are common and the surge in inflation post COVID has been a major headache, prompting massive interest rate hikes. Thankfully the wild inflation numbers of the last couple of years are now behind us.
Over this last quarter, the main unfolding story for investment markets has been the slow progress in finally getting inflation back inside the policy target of 2-3%. Inflation seems to be stuck 1-2% higher than target, meaning that hopes of interest rate cuts keep being pushed back. Which is not good for financial markets.
So, after a very strong start to the year, investment markets lost ground in April as the inflation data disappointed. A typical ‘balanced’ style strategy returned around 5% in the first quarter of 2024 but by early May had retraced a couple of percent.
Goods inflation is well under control. But services inflation has spiked up, pushed along by higher housing rents, a tight labour market and wage settlements.
It’s a delicate game and financial conditions from elevated interest rates are slowing the Australian economy. Consumer spending is already weak and loan delinquencies are on the rise. Nevertheless, predictions are for low but positive economic growth in Australia over the next year. Thankfully the consensus is for no recession in Australia or the US.
Markets are now expecting no rate cuts in Australia or the US until very late in the year, but hanging on to the belief that the next interest rate movement will be down, not up.
Our main investment focus at Grand Plan Wealth is the compounding of wealth for long term investors. Short term returns may be fascinating (at least to the finance types) but they are essentially a lottery. We can be much more confident in long term forecasts, because long term returns are mainly derived from the more predictable earnings that flow out of diversified investment portfolios – profits, dividends, interest payments, rents etc. On this note, Vanguard has updated their long term forecasts. With all the usual caveats they are tipping worthwhile returns across traditional market portfolios over 10 and 30 years, even after the impact of inflation. And because interest rates are currently elevated, even conservative ‘bond heavy’ portfolios are expected to do relatively well.
Reach out to us if you’d like more detail.
General Advice Warning: Any advice included in this article and associated links is general in nature and would not consider your particular objectives, financial situation or needs. If a product we recommend has a Product Disclosure Statement (PDS), you should read it before making a decision. Past performance is not a reliable indicator of future performance. Other than cash deposits falling under the Australian Government’s Financial Claims Scheme, any investment we recommend has the potential to deliver a loss to an investor. Nevertheless, we are of the view that for Australian investors it is reasonable to expect a skilfully managed diversified portfolio to deliver positive returns over the long term, over and above cash returns and the impact of inflation.