Tony Alexander: Be very careful about locking in three to five-year fixed rates

ANALYSIS: You may recall back in the early days of the pandemic that a number of young people in KiwiSaver funds became distressed at the falls in share prices by around 30%. They became fearful of share prices falling further so shifted funds from their growth and aggressively positioned portfolios into defensive and conservative ones.

The only thing they successfully achieved was locking in their losses because they then missed out on the strong rally in share prices which followed very quickly after the early days of Covid-19 hitting our countries.

These young people were intensely gripped by something called regret or loss avoidance. Their focus was not on positioning themselves for future gains but avoiding more losses. The trouble is of course they had not developed any new ability to predict share prices which they did not have before the prices started falling.

Just last week I received an email from an older couple wondering if they should shift money which they had placed into managed funds late last year back into the term deposits they came from. I pointed out that all they would be achieving is locking in the losses they have achieved over the past year and that they had not gained any ability to predict where prices for shares were now going to go. They, like young people back in early 2020, have become driven by a desire to avoid further losses.

The same thing is happening amongst economists and professional financial market participants around the world at the moment. Everyone has got their predictions for inflation and interest rates wrong. Everyone has been forced to revise upwards their inflation forecasts and is well and truly tired of doing so.

They/we have now entered into a position of wanting to avoid having to make further upward revisions. They believe that they (me, us) have an ability to predict inflation and interest rates which clearly was not there two weeks ago, three months, one year or three years ago.

But none of us have seen an improvement in our forecasting ability. We are as useless or mediocre or acceptable as we were at virtually anytime in the past. But driven by a desire not to be embarrassed again we have decided to try and get ahead of the pack by now lifting our interest rate predictions very strongly.

Most recently we have seen the markets pricing in a peak cash rate in the United Kingdom above 6%, in the United states well above 5%, and in New Zealand also well above 5%. But will interest rates actually reach these high levels? Probably not.

Independent economist Tony Alexander: “Everyone has got their predictions for inflation and interest rates wrong.” Photo / Fiona Goodall

We are experiencing a period when we hope that inflation will be coming down but it's really too soon for the impact of interest rate rises to be visible in inflation rates. This is likely to remain the case for the next few months and as we go through this interregnum we should all anticipate continued high volatility in financial markets.

That means sometimes big changes in bank wholesale funding costs along with exchange rates and predictions for economic growth and so on.

For home buyers and home owners the implication is to not panic. We economists know that much as you pooh-pooh our ability to make accurate predictions (fair enough) you're still going to take what we say and what the markets are pricing as a guide to where you think interest rates will go and what you will do something about it.

My warning is that the guidance being given now is likely excessively high. All this adds up to is the following. As interest rates rise a bit further be very careful when you start believing that they're going to remain high for many years and you think about locking in three to five-year fixed interest rates, which clearly you did not touch with a bargepole when you may have bought your property in the first half of 2021 and you could have locked in a five-year fixed rate at a record low of 2.99%.

- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz