Well, once again the RBA ( Reserve Bank of Australia ) lowered interest rates this week ( Tuesday ), this time to a very low figure of 1.50 from the former 1.75 percent. This was one of the markets I was interested in buying early in the week on pullbacks lower to the downside, however decided to avoid this market due to the potential rate drop effect this week. If no change, then it would of been a market of interest however.
Interestingly, this new drop in interest rates had very little negative effect on AUDUSD other than a quick drop and a return to test the previous highs. Can be seen on chart below.
The Australian dollar is one market that I commonly trade, so thought I would give my take on what the reserve is essentially trying to do and how most likely in my opinion it will have very little effect.
Above – RBA drops interest rates to 1.5 percent, above showing small move lower and then strong move back higher to retest the previous highs on AUDUSD 4 Hour chart.
Above – Same market zoomed in.
Why are they lowering interest rates?
The reserve may say different, however in my opinion they are lowering interest rates to help keep the Aussie dollar low, to make it easier to reduce the national debt and because of how much mortgage risk there is in Australia. In particular in the interest only mortgage sector. They are also attempting to stimulate easier lending and while it may not be there complete goal, trying to encourage more lending. Whether government, private or public.
In reference to reducing national debt, lowering interest rates as Australia has over 5 trillion dollars in total debt. Total government debt being over 700 billion and climbing. For more on how much debt, you can view the Australian Debt clock here.
You see, Australia has huge amounts of what some economists refer to as debt acceleration, this acceleration is leading to over valued housing, inflation ( real inflation ) and assets. As debt acceleration is high in this country one way of countering people from being forced to pay back debts is to lower debt repayments for the population and thus encouraging more lending. Most of the time, lending amounts of money that most Australians cannot afford unfortunately.
Now, here is the problem with trying to keep debt acceleration high, is that no matter how much a country ( Australia not alone ) tries to fight or reduce the inflationary acceleration, the more chance it increases the risk of a collapse in sectors such as housing or similar. We can look a other countries that did similar to get an idea of what I mean here.
If you are wondering what debt acceleration is, it is paying for a product or service or asset such as a house with not real money ( such as debt ) and then this leading to the value of a product or service going up like as if one is spending real money. In other words, it can be seen as buying pressure, however not real buying pressure.
Will it work?
In my opinion it does not work as it has never worked in history. Many countries in the world have fought debt acceleration and in the end all of them have failed at the attempt. They commonly fail when interest rates get low and people still cannot afford to lend. In other words they have to start paying back debt with real money, rather than paying back money with more debt.
Paying back debt and slowing down the acceleration then leads to deflation and a correction which of course is what the Reserve Bank is fighting.
Will it help keep the Aussie Dollar Lower?
In the short term, however long term, not very likely long term, most big traders used to factor in these types of aspects however as nearly every country is trying to create a weaker currency, it essentially is often ignored or has very little impact.
In other words, the Australia dollar is a great currency pair to trade still, which still has positive swap if buying against most currencies and many traders will still be buying this market including myself whenever I see a great opportunity.
Who is at risk?
One of the last points I will leave you with is who is most at risk in Australia from debt acceleration, well if we look at how other countries that were effected by debt acceleration in particular in the housing sector ( like Australia ) it was those that owned investment properties. It will have little effect on those owning a house and living in it other than it will be worth less than how much you bought it for. Of course, I am referring to those that do not owe money on there house.
In other words, it will effect those with large debt such as those having a large mortgage as an example.
A reason why it is not a good time in Australia to buy a house, especially with debt and in preference to rent.
How much could the housing market drop?
In my opinion it could drop as much as 40% to 60% depending on location when the debt acceleration slows. This is an estimate based how much debt is in the average house in Australia causing house prices to stay high currently. In other words, I am expecting that the housing market could halve in value as a modest amount.
Be aware that this depends on location, some areas the drop maybe less and some more.
Will interest rates go back up?
Be aware that while they are lowering interest rates now, they can start raising them again. This will lead to those with large debts taking excessive debt during a low interest rate period to suffer and those with no debt and savings to benefit. In other words, what I am saying here is to be responsible with debt in Australia, especially during times like these and do not lend what you cannot afford to pay back, lend based on if the interest rates were more than 6 to 7% or even more.