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Interest rates will peak at lower rates than previous cycles
![Interest rates will peak at lower rates than previous cycles](https://biz-file.com/c/1411/238685.jpg)
However, interest rates are expected to peak at much lower levels than in previous interest rate cycles and this will cushion the impact on consumers.
Tucker also believes that financial planners will become crucial partners for investors in the face of this cycle of rate hikes. "We expect interest rates to rise gradually over the short to medium term. Currently interest rates are very low and inflation remains near the top end of the central bank's target range of 3-6%," he notes.
"On the positive side, gradually increasing interest rates should help ensure that inflation remains within the target range over the longer term. Furthermore, we expect global interest rates to gradually rise from the very low levels seen at present. In this context, some increase in South African interest rates is inevitable."
Reduced imports
Tucker says that higher interest rates will put further pressure on consumer spending with household budgets already under pressure. "With interest rates expected to peak at lower levels than previously, and this cushioning the consumer impact, the recent decline in the oil price is also likely to offset some of the negative impact of higher interest rates on consumer spending. To the extent that higher interest rates slow consumer spending, this should also reduce imports helping to narrow South Africa's deficit with the rest of the world.
"This will decrease a key source of risk for the currency, since this deficit needs to be financed by foreign capital flows into South Africa. Higher real interest rates will also increase the potential return to foreign investors in South African financial assets. This should boost capital flows and further support the currency. In short: while higher interest rates will mean short-term pain, they are necessary for longer term gain."
In an environment of lower economic growth, rising interest rates and consequently lower inflation, bonds offer good value to investors, according to Tucker. "Inflation is the enemy of the bond investor, as it erodes the real value of the coupons received. Therefore, bonds look more attractive in an environment of falling inflation. An additional positive factor for bonds is the improvement in the overall health of our economy as we embark on the rebalancing process.
Lower returns
"While positive for bonds, rising rates in a low growth environment is less positive for equities, in particular domestically linked sectors. However, we believe that roughly 60% of the Johannesburg Stock Exchange (JSE) is driven by factors outside of the South African environment. As such, there are areas of the JSE that could deliver reasonable returns, regardless of the local environment. Over the last few years, exposure to the market was important. Going forward, we expect overall returns to be lower and for stock selection to be a more important driving of fund returns.
"Returns have been front-end loaded due to the increases in liquidity through accommodative monetary policies globally and the expectation of an improving growth environment. It is important to remember that markets are forward discounting machines. They price in what they believe will be happening in the future.
"Consider the example of buying a house. You wouldn't buy a house at full asking price in an area where you expect some factor that will drive the prices down by 10% in the near future. You would rather select an area that looks to be moving in the right direction in your view, and hopefully where the prices have not yet fully adjusted to reflect this view.
"Equity and bond markets work in exactly the same way. Given that real returns going forward will most likely be lower than what we have seen in the past, investors should engage with their financial adviser to ensure that they are adequately positioned to meet their investment goals," he concludes.
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