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Interest rate knowns and unknowns

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by Peter Switzer

What in the hell is going on with interest rates? There’s a new story every day and every one of them is very believable but they are different.

At the risk of doing a Donald Rumsfeld, there is one knowable — rates won’t be cut again in this country in the near future unless some shock of financial Armageddon proportions comes along.

The Rumsfeld view

For the purists with a bad memory, Rumsfeld was the US Secretary of Defense under George W. Bush and this is what he actually said: “Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know.”

But wait, there’s more from Donald and it’s worth noting:

“But there are also unknown unknowns — the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tends to be the difficult ones.”

X factor

So, our focus should always be to be on the hunt for unknown unknowns, if that makes sense.

My old mate, Don Stammer, the former chief economist at Deutsche Bank in Australia made the X factor famous in economics in telling us that it’s the unknown or unexpected event that can really KO many economists’ nice predictions from their complex models.

Analyse this

Let’s use Rumsfeld’s analysis to understand our interest rate future.

First, to things we know we know. Rates will eventually head towards a cash rate of interest around five per cent.

Second, the known unknowns are how high will they go, how long it will take to get to five per cent and when the rate rise will begin.

For example, Craig James of CommSec thinks it starts around March next year but says it could be earlier. Symon Brewis-Weston, who heads up local business banking at the Commonwealth Bank (CBA) says the first rise could be as early as November. Meanwhile, the chief economist at ABN AMRO Morgans, Michael Knox, expects the first rise around mid-year 2010.

Another known unknown is the strength of the recovery in the USA and Europe. This could lead to more demand for money and push up interest rates worldwide and this could force the Reserve Bank’s hand here.

Brewis-Weston said on my program SWITZER on Sky News Business Channel that the CBA is borrowing up to 150 basis points above the home loan interest rate for three-year money right now.

The unknown unknowns

And so what about the unknown unknowns? A colleague tells me that debt markets are really tightening, like they did before the market crashed and that some big companies are finding it difficult to raise debt, though the stock market has been very obliging lately with capital raisings going really well.

Big, bad, bears like my academic colleague, Steve Keen, claims to understand the really big unknown unknown — debt levels. He thinks it will be debt that will bring the economic system down along with house prices, businesses and jobs.

I hope and reckon he’s wrong and that as history often shows, we can muddle our way through, but it will be reflected in a protracted period of subdued growth and rising interest rates. When nearly every big business and big government are in the business of borrowing, something has to give, and that has to be interest rates — that’s a known known.

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Tuesday, August 25, 2009