Ever since the Reserve Bank of Australia (RBA) delivered its first cut in Australia’s official cash rate back in June, we have been told to expect interest rates to hit 0.5% by the end of the year.
If the triple cut 2019 has delivered hasn’t been painful enough for retirees and other conservative investors, a cash rate of 0.5% would essentially render any cash savings instrument such as a savings account or term deposit as useless.
Rates that low might even push Australian government bonds into negative territory, like we have seen in Germany and Japan (although in my view that’s still unlikely in the foreseeable future).
But according to news.com.au, the chance of a November interest rate drop has now been dramatically reduced – with odds of a Melbourne-cup cut falling from 40% to 20%.
The catalyst for this move appears to be positive data coming out of the jobs market. In September, our national rate of unemployment dropped from 5.3% to 5.2% – indicating that this year’s tax cuts might be working as the government intended.
What does this mean for ASX shares?
The first thing to note is a higher exchange rate. The Aussie dollar has jumped on the news and is trading for 68.34 US cents at the time of writing. If the RBA gives a further indication that rate cuts have been put off, our dollar might appreciate further – meaning cheaper imports and more expensive exports.
But it also might mean lower ASX shares. Interest rate cuts lower the ‘risk-free rate’ that investors often value shares with. If you can get a better yield from a bond than a share, you’re probably going to choose the bond. Ergo, lower rates typically mean higher share prices due to the lack of a safer alternative.
Like share prices, no one really knows what interest rates will do next. I tend to think that the cuts will be delayed rather than abandoned, but if you stick to the fundamentals of buying quality ASX companies for good prices, it won’t matter too much anyway!
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.