Rba Rate Rise Knocks the Wind Out of ASX
Comment of the Day

May 03 2022

Commentary by Eoin Treacy

Rba Rate Rise Knocks the Wind Out of ASX

This article from the Sydney Morning Herald may be of interest to subscribers. Here it is in full: 

The Australian sharemarket hit a downdraft when the Reserve Bank of Australia raised interest rates by a surprisingly large 25 basis points yesterday, as the markets digested the implications of rising debt costs.

The ASX 200 dropped 0.4 per cent, or 30.8 points to close at 7316.2 with tech stocks, the health care and industrials the only sectors to close in the black. Miners like BHP, Fortescue and Rio sunk after iron ore prices slumped overnight. Fortescue led the declines with a 4.8 per cent share price drop and Rio Tinto closed 1.5 per cent lower.

Finance stocks also took a hit with ratings agency Standard & Poor's saying home loan arrears are likely to drift up from historically low levels following yesterday's increase in interest rates.

Russel Chesler, head of investments at VanEck, said higher credit costs are likely to dent big bank profits.

"Locally, we are likely to see the big banks come under pressure in the month ahead as higher rates dent the banks' earnings from mortgages and bad debts could jump on higher credit costs." He expects companies which act like an inflation hedge, like gold and infrastructure, are likely to outperform. And despite the drop yesterday, rising commodity prices are expected to support the big miners through 2022.

"In this environment, with inflation running hot and interest rates rising, companies, including cyclical stocks, that can increase their prices and keep their customers at the same time, are likely to outperform," he said.

In other news, the chief executives of Australia's two largest private employers, Woolworths and Wesfarmers have thrown their support behind an increase in workers' wages amid persistently rising inflation and a tightening labour market.

There was also good news about the pandemic recovery, Transurban chief executive Scott Charlton said toll-road traffic has fully rebounded in Australia and is almost at normal levels in the US as businesses and consumers emerge from the pandemic.

Eoin Treacy's view

This is the first Australian interest rate hike since 2010. With CPI at 5% and testing the upper side of a 30-year base formation, the RBA can be expected to continue to hike but perhaps not as quickly as other developed markets.

In 2017, 23% of Australian mortgages were interest only. These kinds of structure are mostly used by investors to gain additional leverage to price appreciation. They are also used by consumers seeking to minimize their monthly repayments for as long as possible. This kind of leverage is heavily dependent on the ability of borrowers to refinance at attractive rates. Since the RBA has been cutting rates for a decade and property prices have been rising, this has not been an issue.

However, the higher interest rates move, the greater the risk of profit erosion, difficulty in refinancing, rising monthly payments and eventually forced liquidations. This is not a process that unfolds overnight but it a likely scenario for how a medium-term interest rate hiking cycle climaxes a few years from now.

The Australian Dollar attempted to steady today from the psychological $0.70 area. This area has offered support on several occasions over the last seven years and will need to hold if medium-term stability is to be given the benefit of the doubt.

The S&P/ASX200 Index was led lower by the real estate and resources sectors today. The Materials Index has been trending higher in a reasonably consistent manner since early 2016. It is currently testing the region of the 200-day MA but a reversion towards the 1000-day cannot be ruled out as OECD monetary conditions tighten.

The Real Estate Index posted a downside weekly key reversal in January, from the region of the 2020 peak and followed through on the downside in emphatic fashion to break the 21-month uptrend. A sustained move back above 3750 will be required to signal a return to demand dominance.

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