Musing on interest rates and currency


Predicting interest rates is no different to any other form of financial market prediction – it’s only a guess and has a very high chance of being wrong. There are just so many inputs into the interest rate outcome. Some people may be asking themselves whether Australian interest rates will rise? Here are some very quick thoughts for those who are wondering about interest rates generally. I thought it would be useful to look at rates from a broader perspective, as some of the recent commentary on rate movements has sounded a lot more authoritative than the underlying facts would support.

Short term or long term interest rates?

It is commonplace to use the phrase “interest rates” as if there really were only one rate available. The reality is quite a bit different.

The Reserve Bank of Australia (“RBA”) establishes an official interest rate, and this is used as a baseline for day-to-day money and loans. It is the benchmark for most variable home loans. However, the longer term rates are generally going to be set by investors and borrowers in the open marketplace. These institutions and individuals will adjust that basic interest rate for any risks that may be involved, and for the timeline that the interest rate will apply for.

Short term rates are down…

The RBA has just dropped short term rates to the lowest levels on record. That has been cause for joy for all mortgage holders on variable rates, as the Big 4 banks have moved to pass on those lower interest rates.

Long term rates are up…

However, at the longer ‘end’ of the timeline, interest rates have been rising. To find out why, we need look no further than the huge pool of money that is the United States government debt market.

When the Federal Reserve openly spoke about reducing their money printing exercises back in April, longer term interest rates on government bonds rose incredibly fast. Australian interest rates at that longer time horizon rose as well.

This is logical for a whole host of reasons but the key point is that our rates rose – almost regardless of the domestic situation here in Australia, and this provides a hint of just how interlinked global finances really are.

Interest rates and Australia’s currency

Remember the “stronger for longer” argument…? The one that suggested Australia’s currency would remain strong even when traditional indicators such as commodity prices suggested it should not.

If you want to see one of the key drivers of our currency, have a little peek at the moves in our dollar versus the USA dollar against the interest rate or yield of the US government 10 year bonds. When the US Federal Reserve suggested money printing would ‘taper’ as the US economy improved, interest rates on those 10 year bonds rose dramatically.

will Australias currency fall when USA rates rise

Is Australia just the tail on the dog? Are our rates really set by own initiatives – or simply by our position relative to the USA?

Our currency plummeted. Interesting, isn’t it?





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