End of year thoughts. Rising interest rates.

As sure as night follows day boom follows bust. 2013 feels like a transition year between the lethargy of the GFC and its impact and what comes next.
The full impact of the GFC in NZ has been masked by government bailout of finance companies, the Canterbury earth quake, and wide spread government works and welfare programmes.
Next year it is widely predicted that interest rates will rise in NZ, and if they do the following consequences are likely assuming the Australians and the US do not raise their interest rates as well.

  • Our dollar will strengthen, and exporters will continue to suffer, resulting in some further insolvency. This said, exchange markets don’t behave as they should in theory, likely rising interest rates will reduce confidence in our economies sustainability and cause our currency to fall. Who knows – it is a guess.
  • Borrowers will have fewer bottom lines to reinvest in their businesses, slowing economic growth (which is why the Reserve Bank raises interest rates in the first place).
  • Cash holders will have more income and retirees will begin to feel less impoverished.
  • Long terms bonds (an investment asset) will fall in value, creating a negative wealth effect for those who are over exposed having opted for long term fixed interest securities.
  • Housing demand will slow down and some will have their household budgets significantly compressed.

Thoughts for borrowers…
Start locking in medium to long term interest rates. Move from floating to fixed rates with a spread of maturities between 3 and 5 years. In doing this you will pay more, say you are paying 5% now and have to pay an average of 6.5% to lock in for 5 years. The extra 1.5% this year and maybe 0.5% the year after doesn’t take long to be paid back if interest rates get back to 8%. To do this the Official Cash Rate (OCR) only has to move from 2.5% to 4.5% to have lending rates in the order of 8%. Also don’t underestimate the advantage of knowing what your cost will be for a reasonable period of time.
Thoughts for Depositors.
If interest rates are going to rise, reduce your term deposit average maturities. The difference between on call cash accounts and terms deposits for up to 2 years is so little that call accounts may be the better option. Long term deposit rates do not yet appear to reflect the likely environment for next year. Deposit rates for terms of 1 to 3 years could make 5 to 6% easily next year.
Thoughts for investors in long term bonds.
During the GFC credit rated bonds were one of the best asset classes to hold. This is no longer the case. If you have a 10 year bond that is trading on a yield of 4% if interest rates move to 6% you won’t be able to sell your bond for its face value or wht it is worth today. This does not matter if you are holding it to maturity (so long as it has a maturity). Perpetual notes, debenture and preference shares never mature. In short, move some of your fixed income securities back into cash so that you can seek to buy new bonds at a higher interest rate as rates rise.
Thoughts for equity investors.
While equity markets have been rising strongly for the last 2 years, as interest rates increase corporate earnings will be impacted – especially for those carrying debt with short maturities or interest review dates. You need to understand the debt profile of the companies that you hold shares in and understand the impact of rising interest rates.
Thoughts for exporters and importers.
Buy or sell forward your currency positions at a rate that ensures you are profitable in your core business. Watch markets closely, volatility will continue as a feature of FX markets in 2014. Picking the trend for 2014 has too many variables to contemplate.

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