How interest rates, trade wars and franking credits affect you
This month, we take a look at the Aussie dollar, how trade and tariffs affect you, and potential changes to franking credits.
1. Why you should care about the Fed raising interest rates
The US Federal Reserve raised official interest rates by a quarter of a per cent in March.
For the first time since the year 2000 you can now get a higher cash rate in US dollars than in Australian dollars.
Why is this a big deal?
Well, for a very long time, the Australian dollar was considered a high yielding currency, and investors globally would invest in the Aussie in order to earn that higher interest rate.
Our rates are still higher than those on offer in Europe or Japan, so it’s still an attractive proposition for some.
Now that rates in US dollars are more competitive though, we’d expect that demand for our dollar is probably going to be lower going forward.
This suggests that we could see a lower exchange rate from here.
Most people with a diversified portfolio of investments will have exposure to overseas assets, and when the Australian dollar falls, assets you own in foreign currency are worth more.
Historically, the Australian dollar has tended to fall more quickly when growth assets like shares come under pressure.
So leaving a bit of your portfolio unhedged in foreign currency, which goes up then, helps to cushion the blow.
2. Should you be worried about a trade war?
Over the last 50 years of increasing globalisation, it feels like the world has become a smaller place.
Improvements in technology and transport mean consumers today have access to a truly global marketplace of products and services.
Another key driver of increased trade has been a reduction in tariffs and export quotas across the world.
In this era of protest politics we’ve seen a bit of a shift in attitudes towards trade, with the US president shocking markets by proposing to impose tariffs on imports of steel and aluminium, as well as targeting more directly some $50 billion of imports from China.
It’s difficult to know for sure how other countries will react, but there are two main things to remember if we do end up in a tit-for-tat trade war.
We will likely see higher inflation, and this will probably just bring forward the next recession.
3. Don’t hang your hat on one income stream
There was a bit of a political surprise here in Australia last month too, as the Labour opposition proposed changes to the way franking credits on dividends work.
This would have a particular impact on investors with low taxable incomes, such as retirees.
Those most heavily affected by Labor’s proposal would be investors who hold portfolios dominated by Australian shares.
Investors generating income from more diversified portfolios wouldn’t be impacted anywhere near as much.
The election is still some way off and it looks like there will be exemptions anyway.
But the sudden panic this proposal caused is a useful reminder of the importance of having a diversified income stream.
If you’re unsure about the impact of these proposed measures, it's a good idea to talk to your financial planner.
Can trade politics stall growth?
Events over the past month have stirred concern for investors as the tit-for-tat trade dispute between the United States and China resulted in rising volatility and poor share market performance.
Other than this, the overall environment for global growth was positive as key economic data points across manufacturing, consumer confidence and employment continued to strengthen.
Our view on the US-China trade dispute
- We don’t expect a full-blown trade war as the costs for both countries will be high. The initial impact of US tariffs on Chinese products would result in rising costs to American consumers and businesses. China’s retaliatory tariffs on US agricultural goods would hurt American farmers and make them less competitive.
- For China, the biggest impact would be job losses in the manufacturing sector but given China’s large state directed policies, those losses would be absorbed more evenly across the economy. We expect there will be a negotiated outcome so that this does not derail the positive economic environment.
- Global share markets fell in March, with the S&P 500 down by 2.7%.
- Europe and Japan were down 2.7% and 3.0% respectively.
- Australian shares underperformed global counterparts, down 3.7%. This was due to a large hit to resource companies following the large monthly decline in the iron ore price, which was down 20%. The banks were also negatively impacted by revelations of questionable lending practices from the Royal Banking Commission.