Having an opinion is easy, but consistently predicting the future is near impossible – especially when the stakes are high.

When the RBA lifted the cash rate for the first time since November 2010 to 0.35%, the cost of borrowing money in the overnight market between banks increased in line with this. Needless to say, borrowers and business owners are getting nervous about the rate hike predictions, and what it could mean for their finances, their businesses and the economy - and rightly so.  So in this uncertain market of rising interest rates, it is important to take a moment to ask ourselves: How are rates set? Who is predicting what? Who is right? And what is the best course of action for borrowers and business owners?

How Are Rates Set?

Firstly, it is worth noting how interest rates are set, via a brief overview of the BBSW, the BBSY and market rates. As a snapshot:

• BBSW: The Bank Bill Swap Rate (BBSW) is the reference rate for all short-term lending over periods up to 180 days (six months). BBSW is the mid-rate between the bid and ask prices the Big 4 (Prime) banks will offer to each other for bank accepted bills and negotiable certificates of deposit for terms of 1 to 6 months. An example of these bid and ask rates for 30 May is as follows:

BBSW Rates

‍

• BBSY: The 90 day BBSY rate (the Bid Rate, equivalent to BBSW + 0.05%) is the reference rate when setting customer funding costs in the business lending market.  This simply means that if BBSY goes up, you pay more interest.  
  ‍
• Market rates: What becomes more interesting is rates beyond 180 days, which are determined by “the market”, collectively being traders and investors in rates or bonds. Long term rates for say 1 to 10 years are determined by what “the market” requires as compensation for lending for these tenors. And the average of what the market requires as compensation determines what the fixed interest rates are for the respective tenors, plus whatever margin the banks want to add to these rates.
  ‍

The market directly influences what we pay for our fixed rates, be it business or home loans, and there is no guarantee they will be right in their forecast of future interest rates.  

On the other side of the equation is our economists, of which there are a long list in Australia, and also includes the economists for our banks. Economists, who are highly qualified, make their forecasts based on what they think will happen to interest rates, but ironically, they do not determine what rates we actually pay for our long term debt – no, this is still “the market”.  

‍

So Who Is Saying What?

So who is predicting what when it comes to future interest rate hikes?

Bond Market Implied Cash Rate vs Big 4 Economists’ Predictions

‍

Economist Predictions

‍

When considering the outlook for the near future, the above graph is an interesting one as it illustrates what “the market” believes forward interest rates will be over the next 2 years or so, versus what the Big 4 banks’ economists (and many other economists) think.  

Clearly there is a significant difference in thinking…  

‍

So Who is Right?

The simple answer to this is – we don’t know.  

The truth is that neither the banks’ economists nor “the market” have been a very good predictor of rates over the last 12 months. In January for example, the majority of a panel of 24 leading economists suggested no rate hikes would be seen until 2023, given the low real wage growth. Bond markets have also been well off the mark, implying a year ago that we would have a cash rate as low as 0.06% next month.

There are several factors that will influence what rates will be in the future, and there are many variables.  

Who knew that Russia would invade Ukraine which would lead to a shortage of oil/gas; grains, and timber - all having inflationary impacts and global upward pressure on Governments’ interest rates as they try to get the inflation genie under control. How long will it take global supply chains to catch up to pent up demand and start to operate freely? How long will it take for housing demand in Australia to meet supply? And we haven’t really seen international borders open to overseas migrants, students and workers yet.  

This may be why “the market” wants to get paid a lot more than what economists think rates will climb to. Why? Because it is “the market” who is taking the risk, and maybe it is also taking advantage of the current uncertainty.  

Why are long term rates in Australia so much higher than the U.S., when we don’t have anywhere near as high inflation or wages growth? The Australia rates for 1, 3, 5 and 10 years are currently 2.59%, 3.34%, 3.58% and 3.78% versus those in the U.S. of 2.08%, 2.71%, 2.81 and 2.85%. If an economy revolves around consumer spending (which in Australia we are particularly focused on), then you would think that an economy where consumers have a lot of debt would be more impacted by interest rate increases than an economy whose consumers have relatively less debt. Australian household debt comprises approximately 126% of GDP versus the U.S., where household debt comprises approximately 79% of GDP. Conversely business and government debt in the U.S. is much higher than Australia. But still “the market” thinks rates here will need to go up a lot more than the U.S.. It is no wonder our economists are forecasting rates at a much lower level.

‍

So What To Do?

Attempting to guess future interest rate movements better than “the market” or the economists is not core business for most people. And we are yet to meet someone with a crystal ball and all the answers. There is noise coming from all angles in the current market. And most participants in most markets add complexity and increase margins, which can lead to greater debt risk for borrowers.  

So, at Balanz, we recommend that the best course of action, especially in an uncertain market, is to proactively manage debt. That is to say:

• Have a robust strategy for debt;
• As part of that, have a core focus on managing debt risk - which includes loan term, covenants, financier, and interest rates; and
• Continually review and manage your debt strategy.

Indeed, regularly reviewing your robust debt strategy is a solid grounding in any market conditions, but crucially so in an uncertain market.

Time to Take Action

So in this complex and uncertain economy, with threat of significant rate hikes in the near future, the time is now to establish or review your debt strategy to ensure it is appropriate and sufficiently robust to see you and your business through the coming rough seas.  

Want to ensure you’re in good stead? Balanz’s team of debt experts can help you shape the best debt strategy for you; your business, and your needs. Lean on us for your financing needs, so you can free yourself to focus on what you do best – your business.

‍

We’re here to help – contact our team at Balanz to learn more.