Global markets appear to be overlooking several significant macro issues, which could make the current interest rate hiking cycle markedly different from its 2022-23 predecessor. The earlier period was absorbed with relative ease, partly due to the substantial cash buffers accumulated by households and businesses during the pandemic. However, most of these excess savings have now been depleted; for instance, US excess savings have shifted from over 10 per cent of GDP to a negative 2 per cent.
A second crucial factor that buoyed economies was the reopening of borders, leading to significant population growth in countries like Australia, Canada, and the US. This influx, particularly immigration-driven, was a major contributor to economic growth through heightened consumption and investment. In Australia, approximately 500,000 net permanent and long-term arrivals over the 12 months to January have powered world-beating population growth. Combined with substantial budget deficits, this has been a key driver of Australia’s economic expansion since 2021, and critically, helped the economy assimilate the Reserve Bank of Australia’s dramatic rate increases and supported house prices, unlike New Zealand which entered recession.
Should population growth slow significantly and savings buffers remain low, the Australian economy could face considerable headwinds. If the Reserve Bank of Australia delivers further rate increases, with the cash rate potentially heading towards 5 per cent, residential and commercial property prices could fall. A second significant macro concern is the emerging ‘credit rationing’ among non-bank lenders overseas. The flood of money into private markets, which enabled the rolling over of problematic loans, is now reversing as capital rushes for the exits. This shift will force lenders to call in loans, potentially leading to defaults and foreclosures, pushing asset prices down.
Coupled with expectations of the US Federal Reserve lifting rates, this scenario could precipitate a severe default cycle. Furthermore, banks financing some non-bank lenders are under pressure to reduce their private credit exposures, which will tighten credit availability and exacerbate the redemption run. While recent cessation of hostilities in Iran may offer a slight reprieve, sustained high oil prices will continue to boost inflation, making central banks more inclined towards globally synchronised tightening cycles. Given these factors, long cash, floating-rate notes, and liquidity are favoured strategies to provide optionality as opportunities emerge.
