ASX shares at risk? RBA's Lowe sounds warning on US rate rises

Inflation in the US stands at 40-year highs.

Key points
  • ASX shares pressured by US rate rise expectations
  • RBA's Lowe warns of potential "abrupt change in financial conditions"
  • Australia's inflation still well below US levels

ASX shares are having a tough time of it today.

At time of writing the All Ordinaries Index (ASX: XAO) is down 1%, having been down as much as 1.4% in earlier trading.

ASX shares in the tech space are doing it even tougher.

The S&P/ASX All Technology Index (ASX: XTX) is currently down 2.4% following an earlier loss of 2.9%.

a woman holds her hands to her temples as she sits in front of a computer screen with a concerned look on her face.

Image source: Getty Images

Why are ASX shares under pressure?

Inflation figures out of the United States surprised to the upside once more. Inflation in the world's largest economy now stands at 7.5%, the highest level since 1982.

That means the US Federal Reserve is more likely to raise rates by more, and more often, than many investors had been hoping.

This saw US share market tumble yesterday (overnight Aussie time), with the Dow Jones falling 1.5% and the tech-heavy Nasdaq closing down 2.1%. And the ripple effect is seeing many ASX shares selling off today.

Abrupt change in financial conditions

Australia's inflation rate remains well below the 7.5% just posted in the US. But that doesn't mean ASX shares are immune to rapid rate increases by the US Fed, the world's most watched central bank.

Speaking at a parliamentary hearing today, Reserve Bank of Australia (RBA) governor Philip Lowe said the surprising leap in US inflation was a "source of uncertainty" for Australia's economic outlook,

As the Australian Financial Review reports, Lowe "warned investors that the country's financial markets are at risk of an 'abrupt adjustment' if surging US inflation forces the Federal Reserve to raise interest rates faster than expected".

According to Lowe:

For the first time in several decades, inflation has become a major issue in the global economy. It's entirely possible that countries with higher inflation rates will need a bigger adjustment in interest rates than currently anticipated. And if so, this could result in an abrupt change in financial conditions around the world including here in Australia.

However, Lowe noted that the current inflationary situation is very different in Australia and much of Asia. "The prices have gone up, so the US is in a very different position than us," he said. "Inflation is not a problem in China, in Japan, in most of south-east Asia."

While Lowe kept the door open for a possible cash rate rise this year, which would throw up some headwinds for ASX shares, he didn't expect the cash rate to reach 2.5% for several years.

Addressing the real interest rate (which takes inflation into account) versus nominal rates (which do not), Lowe said that if inflation in Australia reaches the central bank's midpoint target of 2.5%, a 2.5% cash rate would offer zero real returns, rather than negative.

According to Lowe (quoted by the AFR):

So if we just get to zero real interest rate, then the cash rate would have to average at least 2½ per cent because that's what we want inflation to average. Let's hope productivity growth will be stronger and the return to savers will be positive in real terms.

With today's market action in mind, we imagine ASX shareholders will be watching the developments at the world's top central banks closely.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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