According to the markets, an interest rate cut when the Reserve Bank of Australia (RBA) meets next month on 20 May is all but a done deal. And potentially not just an ordinary, 25-basis-point cut either.
According to the ASX's RBA Rate Tracker, which measures what traders in the bond market are currently pricing in, investors reckon there is a 62% likelihood of the RBA cutting rates by a jumbo 50 basis points on 20 May. That would reduce the cash rate from the current 4.1% to 3.6%.
Now, that might sound like manna from heaven for anyone who is currently servicing a mortgage, particularly considering the steep cycle of rate hikes that Australians endured between 2022 and 2024. This saw the cash rate climb from the COVID-induced 0.1% in April 2022 all the way up to 4.35% by November 2023. So another cut or two on top of the 25-point reduction from February of this year would no doubt be welcomed.
But what would an interest rate cut mean for ASX shares, particularly infrastructure stocks? That's what we'll be diving into today.
Now, theoretically, interest rates have a meaningful impact on the valuations of all ASX shares, as they do with all assets that produce cash flow. However, infrastructure stocks are particularly sensitive to interest rates, given that investors are usually attracted to these stocks due to their predictable cash flows and, by extension, dividends.
Put another way, the kinds of investors who tend to buy infrastructure stocks often do so because they have a strong conviction in that stock's reliability as an investment. If it trades on a dividend yield of, say, 3%, investors assume that's what they'll get.
Why are ASX infrastructure stocks sensitive to interest rates?
Now, if interest rates rise and a government bond offers an improved 3% interest rate, those investors might choose to buy that bond instead, given the returns are, at least in theory, 'risk-free'.
Those investors will probably only now buy that infrastructure stock over the government bond if the stock offers a higher dividend yield.
As such, infrastructure stocks tend to fall in value when interest rates rise to give investors that higher yield. But they also tend to rise in value when interest rates fall, for the opposite reason.
Prominent infrastructure stocks on the ASX include Transurban Group (ASX: TCL), Atlas Arteria Group (ASX: ALX), and Auckland International Airport Ltd (ASX: AIA).
All of these companies qualify as infrastructure stocks. Transurban and Atlas Arteria are both toll road operators, while Auckland Airport is, well, an airport. These businesses do indeed enjoy highly reliable revenue streams, and can thus pay reliable dividends to their investors.
So if interest rates start falling again in 2025, I would expect the values of these companies to begin to rise. There's a reason all three have been lacklustre investments over the past few years, given how much interest rates have risen. But perhaps the RBA's meeting next month will change that. Let's wait and see.
