Are Central Banks Tightening Too Late As Inflation Hits
30 To 40 Year Highs?
Montgomery Investment Management
As I have discussed in recent blogs, US ten-year treasury bonds have risen from approximately 0.5 per cent in mid-2020 and are now approaching 3.0 per cent. At the beginning of 2022, they were 1.5 per cent - and have effectively doubled in four months - as the concept of "transitory inflation" was reduced to rubble from the war in Ukraine pushing up commodity prices, continued supply bottlenecks and the general tightness of the labour markets as many economies exit COVID-19.
In many Western World economies, the rate of inflation is hitting between 30-to-40-year highs and examples include New Zealand at 6.9 per cent; the UK at 7.0 per cent; Germany at 7.3 per cent and the US at 8.5 per cent. Most Central Banks have moved very late in their tightening cycle and cash rates of around 1.0 to 1.5 per cent are still very low by historical standards. Australia's record low cash rate at 0.10 per cent compares, for example, with the "Emergency Low" cash rate of 3.0 per cent implemented on the back of the Global Financial Crisis over 13 years ago.
Much of the Western World adult population have enjoyed an enormous bull market for their prime asset - their house. But with house prices and household debt at record levels relative to household disposable income, indebted households will be sweating rising interest rates, and this could have a knock-on effect.
In the US, for example, 30-year fixed mortgages have hit 5.35 per cent, a 12-year high. Given they were under 3.0 per cent not so long ago, this has added around one-third to monthly mortgage payments on a standard 30-year repayment mortgage. And for those Americans buying today, post the 20 per cent year-on-year increase for the average house, this means they are now paying around 50 per cent more on the mortgage than they would have been a little over a year ago.
Buyers who fixed in a high proportion of their mortgage for some years will be less affected by rising interest rates. In the past I have pointed out that early in 2021, a four-year fixed loan in Australia was sub 2.0 per cent. Today, that rate is closer to 4.5 per cent. What this means is that today's housing buyers are taking out variable loans at closer to 2.3 per cent but are vulnerable to the RBA moving late with the interest rate tightening cycle.
No matter how you cut it, the psychological boost and wealth effect enjoyed from strongly rising house prices will likely be missing in the foreseeable future and this means indebted households are more vulnerable to Central Bank tightening late in this inflationary cycle.
Author: David Buckland, Chief Executive Officer
Funds operated by this manager:
Montgomery (Private) Fund, Montgomery Small Companies Fund, The Montgomery Fund