Over the past week Australian shares were down 0.7% while small company shares were down 1.6%. Shares in developed countries fell 4.6% with the US market down 6.0%. Shares in emerging markets were down 3.4%. The Australian dollar lost 0.2% to 76.99 US cents. The Australian 10 year bond yield fell to 2.65% while the US 10 year bond yield declined to 2.81%. The oil price increased 5.7% to 65.88 US dollars per barrel.
Last week, the US Federal Reserve raised its cash rate target by 0.25% to a range of 1.5% to 1.75%. This is the first time in 18 years that the US cash rate has exceeded Australia’s.
What does this mean? Well it broadly indicates that the US economy is faring better than Australia’s. The US Federal Reserve (the ‘Fed’) has taken the view that the US economy is travelling along well enough to raise interest rates further to ward off inflationary pressures. Meanwhile, the Reserve Bank of Australia (the ‘RBA’) has left the official cash rate at 1.5% since September 2016. While there has been solid growth since late 2016, some have expressed concerns about housing, a stretched consumer, and the economy’s reliance on exports of iron ore and coal.
What are the respective central banks hoping for? The Fed is hoping that their interest rate increases relieve inflationary pressures, and that the economy continues to grow. Meanwhile the RBA is looking for more sustainable and broad-based economic growth; they are not too worried about inflation now.
Different Fed and RBA interest rate decisions and trajectories have the potential to impact on our currency. We could see the US dollar strengthen relative to the Australian dollar. There is a well-known theory that markets offering the highest interest rate attract capital flows to their country which pushes up their currency. However, currency markets are notoriously difficult to predict, especially in the short term.
Undoubtedly there is a lot happening in financial markets at present; there nearly always is! Watching the impact of interest rate increases in the US is right near the top of our list.
David Bell | Chief Investment Officer
Past performance isn't necessarily an indicator of future performance.
Data sourced from Bloomberg and the Federal Reserve.