Rates Are Rising Again. What Matters for Investors?

It is understandable that households with a mortgage would feel frustrated to see interest rates move higher just as inflation appeared to be easing. The Reserve Bank of Australia’s (RBA) recent decision to lift rates surprised some observers.

From the RBA’s perspective, and for many market watchers, the logic is straightforward. Understanding that logic helps investors frame how portfolios should be positioned from here. Importantly, while higher rates pressure borrowers, they also increase income opportunities for investors, particularly with floating rate notes.

Why the RBA Acted

The RBA has two broad mandates; to conduct monetary policy in a manner that best contributes to price stability and the maintenance of full employment in Australia. “Full employment” is inherently imprecise and has no formal target, but the current unemployment rate is well below historical standards and generally regarded as consistent with a tight labour market. 

By contrast, the RBA has an explicit inflation target of 2–3%, as measured by CPI.  While inflation has fallen meaningfully from its cyclical peak of 7.8% year-on-year, the RBA is concerned it may stabilise above target rather than continue declining. As such, inflation management remains the primary driver of policy settings, at least while the unemployment rate remains subdued.

Three key factors appear to have driven the recent rate increase:

• First, inflation progress has stalled. Price pressures eased earlier, but more recent data suggests inflation is proving “sticky”, particularly in services, rents and labour-intensive sectors. This raises the risk that inflation will remain above target for longer than desired.

• Second, the economy has been more resilient than expected. Household spending, employment and business activity have held up better than forecast, with government spending also increasing. A resilient economy gives the RBA room to apply additional restraint without immediately triggering a sharp downturn.

• Third, credibility matters. Central banks are acutely aware of inflation expectations. If households and businesses begin to assume higher inflation is the new normal, it can become entrenched and significantly harder to reverse. A modest rate increase reinforces the RBA’s commitment to returning inflation to target.

In short, the RBA judged that policy was not yet sufficiently restrictive to ensure inflation returns to target within a reasonable timeframe.

The Bigger Picture for Investors

This rate increase should not be interpreted as an attempt to engineer a downturn. Rather, it reflects a desire to complete the inflation adjustment and avoid the stop-start policy mistakes seen in past cycles.

For income-focused investors, the key point is reassuring. Higher rates create more income opportunities and defensive assets once again offer meaningful yield.

Over the long term, investment outcomes are driven less by predicting the next rate move and more by staying diversified and aligned with your risk tolerance.  As always, successful investing is about discipline, patience and consistency — not reacting to every headline. 

What it means for Mutual’s Funds

So how does this translate into portfolio positioning?

Two metrics we report across our funds are Running Yield and Yield to Maturity. 

Running Yield measures the income you earn today, that is the annual coupon or annual income divided by the current price.  It provides a snapshot of current income but does not account for any capital gain or loss at maturity. For example:

Face value of the bond:          $100.00

Coupon:                                   5% so $5.00 per year

Current Bond Price:                $95.00

Running Yield:                         $5.00 ÷ $95.00 = 5.26%

Yield to Maturity (YTM) represents the total annualised return if the bond is held until maturity. Yield to maturity calculations assume all coupons received over the life of the bond are reinvested at the same rate. Yield to maturity includes coupon income, capital gain or loss (difference between purchase price and face value) and the time value of money. 

Turning to interest rate dynamics, the RBA sets the cash rate, which is the price of overnight money. The Bank Bill Swap Rate (BBSW) is the reference rate used to determine coupons on floating rate notes and reflects short-term funding costs. Because short-term funding costs closely follow the cash rate, BBSW typically moves in line with RBA decisions.  

Three of Mutual’s four funds invest exclusively in floating rate notes. As the RBA increases rates, and as the BBSW adjusts accordingly, the coupons on these securities reset, typically every 30 to 90 days. As a result, portfolio income rises progressively as those resets occur – all other things being equal. 

Since the most recent rate increase, running yields and yield to maturity across the funds have moved 6 – 10 basis points higher as coupons begin to reset. As further resets occur, we expect the full 25 basis point increase to be reflected in portfolio yields. 

With the possibility of additional rate increases ahead, there remains further potential upside to portfolio income should policy tighten again.