Adam Scully, senior portfolio manager at Alexander Funds Management, is worried the Reserve Bank of Australia (RBA) may have pushed its aggressive interest rate hiking cycle too far, with rates having surged from 0.1 per cent in early 2022 to the current 4.1 per cent.
Speaking on a recent Relative Return podcast, Mr Scully drew attention to the unique economic situation in Australia, which holds particular relevance for investors.
Ms Scully began by highlighting the Australian consumer’s longstanding trend of accumulating more debt to enter the increasingly expensive housing market. Unlike the US, where fixed-rate mortgages are prevalent, Australia relies heavily on variable-rate mortgages.
“The mortgage market here is a variable rate market as opposed to the US which is a 30-year fixed rate market. So, it has different dynamics.
“Here, any changes in monetary policy generally directly flow into consumer balance sheets. But what we’ve seen over the last few years has been a little bit unprecedented in terms of the local market because due to some of the emergency measures launched by the RBA in response to COVID, particularly the TFF [Term Funding Facility] and the anchoring of the three-year government bond rate. This in effect created that sub 2 per cent three-year fixed rate mortgage that most of the banks were offering over 2020–21,” Mr Scully explained.
While Australian consumers “quite rationally” seized this opportunity to lock in historically low rates, Mr Scully said this significantly altered the mortgage market’s dynamics.
“We went from having kind of minimal fixed-rate mortgages to, over that period, like 70 per cent to 80 per cent of mortgages being written at a fixed rate,” he said.
This change had significant implications for the RBA, Mr Scully said, adding that the central bank is now making policy decisions based on data that may not truly reflect the impact of previous rate increases.
As such, with the bulk of these fixed-rate mortgages set to mature by 31 December, Mr Scully expressed concern that the RBA might have already tightened monetary policy too aggressively. The unwinding of these fixed-rate mortgages, he said, could create “fertile ground for a policy mistake”, potentially straining the Australian consumer.
Mr Scully also highlighted another important factor – the level of savings held by Australian consumers.
During the pandemic, many Australians accumulated savings, often held in offset accounts, increasing their financial resilience in a higher interest rate environment.
Moving forward, Mr Scully explained the psychology of these consumers will play a crucial role in determining the economic impact.
“Based on numbers and analysis, if they [consumers] decided to use all of their savings to support spending, it could keep strength in the economy for another 12 to 18 months. Whereas if they sit there and say, ‘Well, my mortgage rate has gone up, so therefore, I’m going to cut X-Y-Z from my family budget and I don’t want to keep my savings buffer there’, then we could see the slowdown a lot earlier,” he said.
Mr Scully pointed out that many consumers may hold onto their savings, at least until the RBA begins to offer some relief.
Ultimately, the spending of these savings will be a pivotal factor in determining when any economic slowdown might occur.
To hear more from Mr Scully, click here.
