All eyes on interest rates
October 2023
It’s not just mortgage holders and savers who keep a keen eye on interest rates. Both equity and bond investors spent much of the September quarter searching for clues to the next move in rates, while also mulling the prospect of a global recession.
The result of this uncertainty was muted returns from major asset classes, with even the “magnificent seven AI stocks which had propelled the US stock market taking a breather from their previous stellar gains.
Comments from the world’s top central bankers late in the quarter ultimately led investors to the conclusion that rates won’t fall until at least late 2024, even if they don’t rise much further before then.
In this environment, Australian shares fell 0.8%1 in the three months to September 30. The modest decline was led by sectors such as health and Australian real estate investment trusts (A-REITs), while solid gains from banks and miners helped offset the fall.
A drop in the Australian dollar was a wildcard that dented not just overseas holiday budgets, but also any global equity portfolio which uses hedging strategies to offset the impact of exchange rate fluctuations.
An unhedged investment in global shares returned 0.4% for the quarter, while a hedged investment suffered a decline of -2.7%1.
A falling dollar boosts gains from unhedged offshore investments because earnings from overseas companies are worth more in Australian dollars – but erodes the impact of portfolios which are hedged for currency risk.
Local bonds lost 0.3% in the three months to September 30, and the dawning realisation that global interest rates are unlikely to fall anytime soon stripped 2.1% from international bonds1.
Where to next?
A mild US recession is more likely than not in 2024, although the potential for it to avoid an economic downturn altogether can’t be ruled out. This dictates a cautious approach to global equities in the months ahead.
The likelihood of an Australian recession is less, so local shares are generally better placed than their global peers. Additionally, potential moves by the Chinese government to revive its flagging economy would bode well for many Aussie companies as China’s remains our largest trading partner.
Official interest rates in Australia have likely reached their peak and US rates may rise just once more by year-end. This environment means government bonds should rally to become a more attractive investment opportunity over the next year.
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1 Source: Bloomberg, 30 September 2023
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