Riding the interest rate rollercoaster - Matt Tod, Findex

Findex associate partner, wealth management, Matt Tod says we are unlikely to see immediate results from loosening monetary policy, as banks take time to implement changes, and mortgages take time to roll off existing terms.

Matt Tod is an associate partner, in wealth management, at Findex.

OPINION

Three years ago, I wrote an article on how rising interest rates may impact your financial plan. At that time, we were at the beginning of a monetary tightening cycle, during which the Reserve Bank of New Zealand (RBNZ) would move the cash rate from a low of 0.25% to its current level of 5.50%.

The Reserve Bank’s policy of higher interest rates has resulted in increased term deposit rates, benefiting investors with a cash-only strategy. While global equity markets have enjoyed significant success during this period, the local bourse has faced more challenges.

Bond investors who have been hit hard during this cycle however remain well-positioned to take advantage of the next phase. Property investors have likely been disappointed, as returns in this market have been poor. Rising interest rates directly impact the ability to borrow and pay mortgages and rent. Unemployment has risen, and New Zealand’s GDP has stagnated under recessionary conditions.

In conclusion, the best investments during this period were international equities and cash. However, it is unlikely that many opted for this strategy. A well-diversified portfolio with an overweight cash position and a tilt to global equities would have performed satisfactorily while maintaining liquidity when funds were needed.

Now, let’s consider the next phase of the cycle. The RBNZ has been successful as it looks to get inflation under control, keeping it within the target range of 1% and 3%. However, high interest rates are stifling growth. Investment becomes uneconomic when money is so expensive. Unemployment is rising, mortgage payments are crippling household expenditure and recessionary conditions in New Zealand are likely to persist until the cost of money reduces.

The next phase will likely see the RBNZ cutting the official cash rate, effectively reducing the cost of money. This could alleviate pressure on households and improve their ability to spend, save and borrow, thus stimulating much-needed economic activity. Business may become more confident and employment intentions could improve.

However, we are unlikely to see immediate results from loosening monetary policy, as banks take time to implement changes, and mortgages take time to roll off existing terms. Government spending is also likely to remain restrained.

The timing and extent of monetary policy relief will depend on the RBNZ’s monitoring of economic indicators.

Continued weakness in New Zealand’s economy prompts the RBNZ to cut interest rates further than what markets are predicting. However, the risk of returning to a period of heightened inflation will remain a concern. The RBNZ has little control over international events and how this could impact local inflation. I predict a slow but sustained loosening of monetary policy.

We will watch with interest as the RBNZ moves into this new phase.

Falling interest rates will pose challenges for your retirement plan, especially if you rely on term deposits to meet your income needs. You could potentially see a drop in income from term deposits of between 25% and 50%. Is this level of volatility acceptable to you and your goals?

The following strategies can be employed to mitigate risk in a rising interest rate environment.

1. Diversification: As always, this is a proven strategy to mitigate risk. Invest across various asset classes, and make tactical tilts in portfolios to take advantage of changing economic conditions.
2. Laddering fixed income investments: By investing along the yield curve with a mixture of maturity dates, you can minimise the impact of changes in interest rates and the direct impact this may have on your retirement income.
3. Review and adjust your retirement plan: Regularly review your retirement plan with a financial advisor to ensure it remains aligned with your goals and the changing economic environment. Adjustments can be made to your investment strategy, savings and spending and retirement timeline as needed to account for the impact of falling interest rates.

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