THE global financial crisis and recession brought interest rates in most countries to their lowest levels. The goal is to use a low interest rate policy to flush money into the economy and hope that such money will help stimulate by increasing consumer spending and reducing costs of capital for producers.
Most countries, if not all, are recovering, but at different paces. Even debt-laden countries such as Greece also see improvement from the 2008 setback. One can't deny that if the world starts to recover (despite at a slower pace than anticipated earlier), pricing (inflation) pressure will start to be a concern once again, hence the easy money that comes with a losing monetary policy (low interest rates) will soon be normalised.
Evidence can be taken from fast-recovery economies such as Australia, New Zealand and some others in Asia, which are seeing inflationary pressure, and are starting to normalise their losing monetary policy by raising the interest rate cycle.
For Thailand, several key indictors such as exports, consumption and even investment, are demonstrating strong and sustained recovery since the second half of 2009. Inflation also starts to pressure the economy, particular on some key volatile items such as energy and food.
To help curb inflation pressure, the Monetary Policy Committee has started normalising the country's interest rate by raising the rate by 25 basis points to 1.5 per cent at its last meeting. This will mark the beginning of tightening the monetary policy to ensure that the economy will grow at a sustainable pace.
The rate will have the potential to rise to 2 per cent by the end of this year and possibly 3 per cent at some point next year, given that the Thai economy will grow as anticipated. The IMF recently expected Thailand's real GDP to expand by 7-8 per cent in 2010. How far the rate will rise also depends on external factors such as the uncertainty of the contagion effect from the European debt crisis, the slowdown in China's economy, also as regulation uncertainty in the US will have an impact on its financial system and a potential spillover to the global economy.
In short, the rate normalisation process is already happening, but to what extent remains uncertain.
For investors, this may be a good period to revise portfolios and realise how rising interest rates will affect them. Investment convention simply states that a rising interest rate is coped with by lowering the bond price. This general term simply suggests that during the rate normalisation period, long bonds suffer the most among all asset classes, particular from duration risk that leads to a loss of capital.
However, short bonds have less duration risk and may benefit from a lower chance of losing capital, with potential gain from rolling yield.
In addition, on the question of what asset class is suitable to invest in during the rate normalisation period, my recommendation is based on two phases of interest rate normalisation as follows;
The recovery phase is an early stage of economic recovery and the beginning of a tightening of monetary policy (rising interest rate). For this phase, I recommend short-dated fixed income such as short-dated deposits, short-term corporate bonds, money market funds, and short-term fixed income funds.
Investment assets associated with global recovery such as commodities (in particular oil and agricultural products) and equities will also benefit in this cycle, as the beginning of global recovery will help boost demand for commodities and help increasing corporate earnings, while the affect of a rising rate is initially not a concern. Two assets are long-dated bonds and gold investments.
As for long-dated bonds, these will suffer from potential capital loss during the rising rate environment. For gold, the investment demand will likely deteriorate in anticipatiion of shifting from no yield to higher yield assets (i.e., short-dated US treasuries).
The saturation phase is a later stage after the raise of interest rates. For this phase, investors should favour switching from high-growth stocks and commodities (such as oil) to defensive high-dividend stocks, as the corporate earning outlook will likely deteriorate from the higher costs of capital and saturated global demand.
Investors should also switch from short-dated to long-dated bonds as the benefits from rolling yield for short bonds starts to subside, while long bonds start to gain tracking on capital gain from the potential fall in bond yield. Investing in gold, as a safe haven asset and protection of purchasing power, is a good choice for this phase.
Regardless of choices of investment deemed suitable during this rising rate environment, investors should have adequate financial skills, knowledge and information before making a decision to invest, because each investment has its own risks.
Win Udomrachtavanich is senior executive vice president and chief investment officer of Asset Plus Fund Management