Will Interest Rates Rise or Fall in 2017? Answer: Yes, and no...

Every day clients ask me about rate increases in 2017. Yet, nearly all indicators point in the opposite direction:

1. Negative GDP growth in the first quarter (Jul - Sep 2016), with a recession to be declared if the December quarter is also negative, according to the ABS on March 1.

2. Pessimistic global projections from the OECD, IMF and World Bank for 2017.

3. Lackluster Australian consumer confidence and business confidence, according to surveys by Westpac and others.

4. An inflation rate of 1.5% for 2016 representing a 19 year low.

4. Big 4 bank predictions of rate cuts, the NAB in particular expects the RBA to cut twice.

The US has raised rates, however no one else is contemplating such a move, publicly at least, whilst there are more global economic headwinds than I have listed above, for example; China's US$5T debt, Brexit and President Trump.

So do I believe that rates will rise in 2017? The answer is yes and no. I believe that the banks are currently raising rates out of step with the RBA, so that when the RBA cuts and political pressure forces the banks to also cut, that they will in fact be giving nothing back, other than their recent increases, or more likely, only part thereof as they seek to preserve profits and maintain shareholder dividends.

I believe that the only questions are:

1. How low with the RBA go?
2. How much will the banks pass on?

Therefore, and it is only my opinion, I suggest that by December 2017, that rates will be lower, or at least no higher than they are here in January 2017.

 

Meanwhile rates for investors are going up.

It's been discussed on here quite a bit already - interest only + investment lending is likely to have a continued significant upward pressure placed on rates.

Owner occ rates, these have been yo-yoing, but the spread between 'cheap' lenders and Big 4 discounting is starting to widen again as banks lose interest on competing through rate for market share.

 

Upward pressure when we have 1.5% inflation, declining business investment and perhaps a recession? There is a risk that banks will face increased borrowing costs in the year ahead, due to global factors, however these will likely be offset by RBA rate cuts. Politically, especially with negative, or even near zero GDP growth, the government will be doing all they can to pressure the banks into lowering rates for investment loans, and across the board for that matter. Globally the trend is toward negative rates is growing, with talk of other extreme measures such as 'helicopter money.' People seem to forget that Australia is a part of a global economy.

 

Problem is there are competing interests.

I personally believe the RBA should have cut harder and faster than they had in the interests of the larger economy. But then make sure not to leave them too low for too long.
Now they are stuck trying to cut when Overseas rates are moving up again.

What continually held them back was an overinflating housing market. The regulatory framework just wasn't right and is probably still not right.

I think from the RBA's perpective we should be on a cutting bias.

On the other hand we source so much funding from overseas, so we have to take into account those factors.

That is:
1) Our Credit Rating and the will they/won't they cut arguement.
2) Basel/APRA changes. More emphasis on securing more long term funding.
3) The direction of those overseas funding markets.

I don't dought that direction could change quickly.

 

I completely agree about the tardiness of the RBA, however who is increasing rates, apart from the United States?

The UK cut to a record low of 0.25% in August 2016.

Japan is holding at -0.1% as of December, that's minus .1! They were considering 'helicopter money' recently.

Globally, the momentum is down, not up with no global economic improvement being predicted by IMF, OECD or World Bank until about 2018, or later.

 

You need to get your head around the RBA cash rate vs the costs of funds. They used to move in unison. They havent since the GFC.

You also need to get your head around BASEL IV, and the requirements Australia's banks will need to meet by mid 2018. Its widely expected that there will be further capital raising required, and its also widely expected that RMBS minimum terms will need to be moved to 12 months. Currently most RMBS is 90 or 180 day terms. Both these things will increase the cost of funds, by 20-40 bpts, according to conservative estimates, meaning further rate increases.

You also need to get your head around the yield curve of 10 year US treasury bonds. We have already seen the effect on fixed rates. Big jumps by most lenders before Xmas. If Trump issues another trillion of US debt to fund his infrastructure plans, yields could climb further, meaning further rate increases

While all of these things are "yet to be determined" at this point, they all point to a very strong chance of funding costs going up....

Any rate increases that follow that wont be applied evenly. banks are capped at 10% I/O speed limits, but are uncapped in the P&I space, so they will compete most aggressively for P&I business, and I/O borrowers will pay to subsidise P&I borrowers....

At best, RBA cash rate reductions will offset those increases.... but if there are no cash rate reductions, funding costs are likely to push the rate to borrower, higher.

So while the RBA cash rate used to drive rates, it just doesnt any more. Its been a long time since the cash rate has been the driver, in fact. 8 years after the GFC, and literally dozens of examples of banks moving rates independent of the RBA, and it appears that is still not understood.

Bottom line is this - funding costs are the driver of the rate to borrower. RBA could cut the cash rate to 0.5% and the rate to borrower could still increase, is the point. Thats an extreme example, but thats how it works now....

 

I do have my head around the cost of funds, however it is combination of the cash rate and the cost of funds, that drives rates. If this was not the case, we would have seen no cuts from the banks last year. The banks have also increased to maintain their share values, profits and dividends paid.

With global GDP stagnating (according to IMF), and Australia's also stable or falling, the banks are not going to risk pushing hundreds of thousands of borrowers into arrears, or risk deflating the property market, with higher rates. They learned that lesson in the early 90's.

We simply cannot ignore global trends and events and say that banks are going to increase rates due to rising costs, despite the cash rate falling and conditions stagnating or not significantly improving. This scenario simply does not add up.

 

The banks have absolutely ZERO appetite to reduce their ROE.

So while I agree that rates likely wont move much, it wont be because the banks are afraid to move them. It will likely be because funding cost increases will be absorbed by 1 or 2 RBA cuts that the banks will just hold on to. But for I/O borrowers, who the banks are motivated to "incentivise" or "convince" to move to P&I - I expect further incremental gouging.

 

I agree, except I believe that political pressure, from LNP and ALP and others, will force the banks to pass on something, as they have in the past. The pressure, with threats of a royal commission etc, are however increasing. I pity them to some extent, they are literally between a rock and a hard place.

 

With all due respect, you are getting it all quite back to front. Political Pressure? Banks.... You're kidding us , right?

The election is done. The Royal Commission is off the table. Shorten didnt win. Turnbull gave us that hard hitting "senate enquiry /wrist slapping" exercise where the banks were called to Canberra for a few days of telling off - also done, and long forgotten.

Its back to business for the big 4. They just slapped everyone with a 0.1 - 0.15% rate rise before Christmas, and 40 bpts or more for LOC's and fixed rates and SMSF's... and no one even blinked.

They have over 135 Billion in RMBS debt to roll over this year, into a securitisation market where US treasury yields are now the highest in a long time... be under no illusions that the banks will refinance on less favourable terms than they had. Wholesale investors will be looking for better spreads. Result - cost of funds increases.

The way its looking , unless the RBA cuts the cash rate to offset funding costs, retail rates will be higher this year - cos the banks arent going to give away 1 cent of margin. Not in a protected, overly regulated , monopoly banking sector such as Australia's, where the barriers to entry for competition are far too high. And Im not convinced the RBA will cut, even with the low CPI data. They are extremely concerned about Sydney and Melbourne prices and general household levels of debt. I bet they'd actually love to raise rates if they could...if it wouldnt drive the AUD up. They are stuck with a serious conundrum.

 

I agree, however the RBA cannot ignore:
1. Declining domestic business investment
2. Declining GDP likely in the December quarter or a possible recession.
3. Inflation below the RBA's target range.
4. Likely rising unemployment this year.
5. Declining global conditions and falling interest rates.
etc etc

The issues you mention, rising costs, are also global issues faced by all countries and their banks. Yet, rates are falling overseas. The RBA will cut and the banks will pass on as little of the cuts as possible, however pass on something they will.

 

do you mean that central bank cash rates are falling? or cash rates are staying the same and retail rates are falling?

I can see that central bank cash rates have come off a little in 2016 in most countries, but I dont see this as evidence that retail interest rates have fallen . Central banks, summary of current interest rates
( just quietly, take a look at Brazil and Russia. Ouch! )

Is there any evidence that retail rates ( rate to borrower) have fallen of late, around the world?

US mortgages have all just gone up. But they are overwhelmingly fixed rates, not variable, so its the treasury bond yield that did that, not the fed rate increase.

U.S. Mortgage Rates Jump to More Than 2-Year High After Fed Hike

 

The key to this question, is to look beyond the Australian media, which appears to be oblivious to what is actually occurring globally.

A quick Google reveals a multitude of reasons for further easing:

"At the start of 2016 the market was pricing in that the Bank of England would raise rates by the end of the year. However, weak economic data, bouts of falling prices (negative inflation), concerns over the slowing global economy and the Brexit vote meant that the UK economic outlook deteriorated so much that the Bank of England actually cut interest rates from 0.5% to 0.25% in August. Interest rate rises now look unlikely to occur for years. The market had been pricing in another possible interest rate cut in 2017 until the continued weakness of the pound raised concerns that inflation would soon pick up."
When will interest rates rise? - Latest predictions

Japan has negative official rates and still inflation is falling, needless to say they won't be tightening monetary policy by increasing rates:
Japan's annual consumer prices fall for first time in four years

As for the US, here's what the Australian government and banks do not want to see happen here:
"Mortgage interest rates came down slightly to end the year, but not enough to end the bleeding in the home-loan market. Mortgage application volume plunged 12 percent for last week, seasonally adjusted, from two weeks earlier."
Mortgage applications tank 12% to end 2016

Anything that risks housing price deflation, will be avoided like the plague.

Look at the IMF's predictions, which mirror the OECD and World Bank:
"Global growth is projected to slow to 3.1 percent in 2016 before recovering to 3.4 percent in 2017. The forecast, revised down by 0.1 percentage point for 2016 and 2017 relative to April, reflects a more subdued outlook for advanced economies following the June U.K. vote in favor of leaving the European Union (Brexit) and weaker-than-expected growth in the United States. These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer."
IMF World Economic Outlook (WEO), October 2016: Subdued Demand: Symptoms and Remedies

The fact is, no one major economic body or institution is predicting a tightening of monetary policy in the near future. Yes, the banks will tinker with rates, however central banks will be forced to ease further to compensate.

Google is your friend, I suggest that those who seem to think that rates will be higher at the end of 2017, than they are now, really need to research the global outlook more widely, and overlook the Australian media. You will quickly see that the world is expecting, and urgently requiring, further economic stimulus, and this includes further easing of monetary policy. However, it does appear that extreme measures, such as helicopter money, do appear to have been placed on the back burner, for now at least.

I hold undergraduate and postgraduate business degrees, and I take a broad and holistic approach to these matters, taking into account the global economic historical and contemporary trends. I fully concur with NAB's chief economist, and others, we will see further RBA cuts this year. I, like many, see the first key date being March 1 when December quarter growth is released. If we are in recession, and recent increases in commodity prices may just allow us to avoid continued negative growth, then we will likely see the RBA cutting in March, they will really have no choice at that point.

 

I fully concur with NAB's chief economist, and others, we will see further RBA cuts this year. I, like many, see the first key date being March 1 when December quarter growth is released. If we are in recession, and recent increases in commodity prices may just allow us to avoid continued negative growth, then we will likely see the RBA cutting in March, they will really have no choice at that point.

You can watch every one of the big4 Banks AGM'S on youtube ,and as i sat through each one, all had opinions and predictions but most were on the same page when it came to funding investment io ect loans and with the stock market lurching again,plenty of investors would now be nervous about rates as they are already starting to climb again,plus had a offer for 3-6 six month fixed term for this week from one of the big4 banks at 3% for cash equivalents..

 

I feel a sense of deja vu. The same doomsayers predicting rate rises now, ( in the face of a deteriorating global economy no less! ), are the same people who were predicting rises for the year ahead on Jan 28 2016. Yet, here we all are with lower rates, both a lower RBA cash rate and a lower rate from our banks, than we experienced on Jan 28 last year.

I for one, are enjoying an average reduction of about 25 bps (0.25%) across several lenders (1st and 2nd tier) and loans. Anyone paying more on Jan 28 2017, than they were 12 months ago, really needs to question who is advising them. Yields are also increasing, from my personal perspective (I alway increase rents by at least 1-3%, to compensate for inflation), but that's another discussion.

I personally expect to save a further 0.2-0.5% by Jan 28 2018. In a way, I would prefer this was not the case, and that the global economy would finally show signs of a significant and sustained recovery from the GFC, however this is not likely for at least another year, or more likely several years, according to the IMF etc.

 

I meant to reference the NAB's prediction of two rate reductions in 2017, there are multiple references available as this has been their view of over 6 months. The latest being from today's Australian (Jan 28 2017):

http://www.theaustralian.com.au/bus...y/news-story/62570d79ba28166412eb4e00351ea2a2

Refers to both NAB and Westpac expecting an easing by the RBA, NAB this year and Westpac predicting a cut next year, which is nicely in line with the IMF outlook for 2018. Who knows how much the banks will pass on, personally I am assuming about half i.e. 0.25% this year, and likely a little more if ABS December quarter growth figures, released on March 1, reveal that we are now in a recession.

 

? Are you sure? My rate now is higher than Jan 28 last year. This is with ING, who were one of the last lenders to increase rates

 

Does it matter who is increasing rates beside the US?

If the US raises rates, then naturally money will flock there. Ofcourse our banks will have to stump up more money to compete for those funds.

Ofcourse the RBA should be cutting locally, but banks have to source a huge amount of their funding from overseas.

 

Look at this issue from the other side. Those that are suggesting that rates will continue to rise, either through rises in the cash rate courtesy of the RBA, or through the banks independently raising rates, regardless of the reasons, are effectively predicting economic suicide on the part of the banks and/or government, given the worsening economic climate globally, and here in Australia.

Every economic text book ever written, and every lesson ever learned during recessions and depressions, tells them that they must not raise rates when growth and inflation are flatlining or worse. To do so would be pure insanity. It defies all logic and common sense, to suggest that banks or our government will intentionally march down the road to further economic deterioration.

As I've said above, the banks have only recently raised rates out of cycle, to allow them to 'cut' in 2017 as the RBA cuts 25 to 50bps.

 

I am an experienced portfolio investor and a finance broker, I am well aware of how much interest I am paying across a number of mortgages, and it is less than it was this time last year. 2016 was a very good year for many investors, including myself.