Bank lending competition has plummeted in 2024 with pricing of commercial debt being more risk-reflective than bank-competitive and in the home loan market, cashback refinance offers and ability for bankers to price competitively to win a deal being stripped back. Off the back of this, there has been a renewed interest in fixed rates as for the first time since the start of 2022 where rates kicked up quickly, fixed rates at the 2, 3 and 5 year mark sit close to or below variable rates.
The raw data is quite simple. The market is pricing in a drop in interest rates. This can be seen in the above graph where the cash rate and 90 day bank bill rate track quite close to each other, but towards the end of 2023, the 3 year rate drops below the RBA cash rate and 90 day Bank Bill Swap Rate.
This indicates an expectation in the market that interest rates are going to fall. The main reasons for this have been widely publicised: inflation has slowed and unemployment rates have steadied. These are the key metrics that the RBA seeks to manipulate as it adjusts the cash rate.
There is some other underlying evidence that the economy is going to slow down and the RBA may want to adopt an expansionary position.
Business confidence (NAB) is one key measure. The business confidence index is expressed as a positive or negative figure relative to the previous month and takes into account forward orders, capital expenditure and inflation outlook. As you can see above, over the last 15 months it has been flat with some larger negative months but few positives outside of Jan 2023.
This is reflected in the capacity utilisation index (NAB).
Capacity utilisation rate is a measure of the usage of labour and capital available within Australia. The trend over the last 15 months is a steady drop. Digging into the figures the primary contributors are construction, transport and manufacturing, which suggests that, in line with business confidence, business is producing less in anticipation of selling less.
All of this evidence points to a reduction in rates, but the question is when. One may conclude that hedging is not a good idea as after 3 years the rate you are paying may be higher than the prevailing variable rate, however it is really a question of how long you spend ‘in the money’ and ‘out of the money’, and your views on when rates will fall if you believe this to be the case. If you think the current cash rate has a while to go, locking in rates may be a viable option. It is also, of course, a good option if you want rate certainty rather than trying to pick the market.
