Those rubbing their hands in glee at the thought of the official cash rate falling to 1% tomorrow will soon have sore hands. It turns out the Reserve Bank of Australia (RBA) could be cutting interest rates deeper and longer than what most are expecting.
Interest rates in the US are set to fall to zero, predicted the head of bond, income and defensive strategies at Pendal Group Ltd (ASX: PDL), Vimal Gor, in an article in the Australian Financial Review.
ASX investors should be alive to the prospect that rates in this country could be heading in the same direction and that cheaper debt has more than overcome the threat of a trade war and weaker earnings outlook to take the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index to 11-year highs in the closing moment of FY19.
What 0% interest rates mean for the ASX
The RBA and the US Federal Reserve are by no means joined at the hip, but zero rates mean that the Fed will have to cut the Fed Fund Rate 10 times by 25 basis points (the interest rate in the US is 2.5% compared to our 1.25%).
Such a drastic move will likely force the RBA to lower rates below the 1% to 0.75% mark that most mainstream economists are forecasting.
While growth stocks will also benefit from lower for longer rates, many have already enjoyed a strong run, and income stocks are likely to dominate the spotlight in FY20.
Some of the market’s favourite income stocks include the likes of Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA), Transurban Group (ASX: TCL) and Sydney Airport Holdings Pty Ltd (ASX: SYD).
How likely are we to hit 0% rates?
But how believable is the return of the zero-rate environment? Afterall, we aren’t in the midst of another global financial crisis.
Gor points to the explosion of global debt as a factor to support his thesis. Debt in advanced economies stood at only 31% of GDP at the end of 2007 but has surged to 266% at the end of last year.
Further, the popularity of the German 10-year government, which is yielding a negative 0.3% (yup, investors are happy to pay the German government interest to own its bonds), gives him another reason to believe in the zero future.
Neutral rate setting could be lower than market expectations
What’s alarming is that Gor believes if the RBA were to lift rates above 2%, it would unleash the same “mayhem of consumer credit stress as that experienced in the depth of the crisis”.
If he is right, what this means is that the “neutral” rate is closer to 1% and where local rates are at the moment can’t be considered stimulatory.
Australia has to go through a painful deleveraging cycle if we are to return to sustainable growth. While ASX investors can continue to celebrate the lower for longer rate cycle for now, we should be prepared for the day of reckoning somewhere down the track.
Until I can smell the sulphur, I intend to make the most of the rate cut euphoria!
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