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Investors face tougher chase for yield as RBA joins sub-1pc club

Glenn Freeman with AAP  |  01 Oct 2019Text size  Decrease  Increase  |  
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The hunt for yield just got tougher as the RBA cut the cash rate to a historic low of 0.75 per cent, reducing the cost of borrowing for the third time in five months.

The market had largely priced in Tuesday's 0.25 percentage point cut despite lingering doubts over whether the move will deliver the desired lift in household consumption.

The RBA cut the rate in both June and July in a bid to shake the country out of economic stagnation, holding at 1.0 per cent during August and September as it observed whether the cuts - as well as the federal government's tax offsets - had flowed through to the economy.

But there have been few signs so far that this has had an impact anywhere but in the housing market, where prices have shown signs of ballooning again in the major Sydney and Melbourne markets after a two-year downturn.

Unemployment and underemployment continued to climb in August, while retail spending also disappointed as experts suggested deeper structural reforms or more government-led stimulus was needed to kick-start growth, which has slowed to its weakest pace since the GFC.

In his statement on Tuesday, RBA governor Philip Lowe said the board decided to cut again in an attempt to eat into that persistent labour market slack.

"The board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes," Dr Lowe said.

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The Australian dollar spiked from 67.47 to 67.61 US cents immediately after the decision before plummeting to 67.36 by 2.40pm, Sydney time.

How should investors respond?

Morningstar's overarching view on such market developments is to avoid knee-jerk reactions, and instead focus on a long-term investment strategy.

As Morningstar Investment Management UK's chief investment officer Dan Kemp has urged in relation to the Brexit turmoil: "sit tight and remember that most investors make too many decisions rather than too few."

Similarly, investors who price in such low rates over the longer term are making a mistake, says Morningstar Investment Management Australia's head of multi-asset portfolio management Brad Bugg.

"We think the market is pricing these very low interest rates out into the future – 10, 15 years and beyond – but we think eventually rates will normalise and go back to levels higher than they are,” he says.

Australia 6th lowest on rates

Australia is now equal sixth globally in terms of interest rate lows, notes Anthony Doyle, global cross-asset investment specialist at Fidelity International, and is on par with the UK, "an economy that is currently grappling with Brexit-induced uncertainty".

Doyle says the current move by the RBA reflect its concern about meeting its inflation target of between 2 and 3 per cent – at a time when Australia's 5-year breakeven rate, a measure of future inflation expectations, sits at just 1.2 per cent.

"In cutting rates so aggressively this year, the RBA is hoping to generate a stronger labour market, higher wage growth and to stimulate domestic consumption," Doyle says.

Doyle expects ongoing easing in Australia's monetary policy will boost domestic economic growth prospects, but highlights the RBA's continuing concern about the prospects for global growth.

"Given the global economic backdrop, and a low inflation outlook, the RBA is likely to continue to retain its easing bias," Doyle says.

Several economists, including Tony Morriss from Bank of America Merrill Lynch, Michael Blythe from Commonwealth Bank and QIC's Matthew Peter, have suggested the RBA will eventually implement quantitative easing in Australia.

But Doyle notes that Australia has the benefit of being able to learn from the experience of such measures implemented by other central banks.

"The mere fact that interest rates remain close to zero almost a decade after quantitative easing was implemented in [US, UK and Germany] and inflation remains uncomfortably low for many central banks, suggests that QE is no magic cure for an economy’s ills.”

He questions the effectiveness of any bond-buying program for a small government bond market like Australia.

“Despite record low interest rates in Australia, the case for QE is not a strong one. QE works most effectively when the bank lending channel is broken or in need of repair. This is not a situation that the Australian banking system finds itself in.

"The unemployment rate remains low, and the Australian government has room to stimulate the economy via fiscal spending if needed. If it is considering QE, then maybe the RBA should think twice," Doyle says.

Retirees hit hardest by rate cuts

Commenting from the perspective of Australia's 3.8 million retirees, Don Hamson, managing director of Plato Investment Management, suggests such investors should review their income-generation strategies in light of today's rate cut.

"Retirees living off cash-linked income are already struggling to make ends meet, and this cut will further crimp their income,” Hamson says.

"So, it is very timely for retirees to reconsider their income-generating asset mix. Thankfully, given the somewhat surprising election result, retirees can continue to bank on receiving franking credits from Australian share investments.”

He suggests many retirees look beyond typical dividend payers such as the big four banks and Telstra for sources of income.

“Dividend increases, for example, have been largely concentrated in the resources sector, with traditional income stocks like the big four banks and Telstra either maintaining or cutting dividends.

“A cut in interest rates - while it won’t lead to an increase in dividend income - may lead to increased investor demand for dividend paying stocks, potentially raising the capital values of some.”

Fixed income with a difference

As rates plumb new lows, several companies have been suggesting alternate sources of reliable investment income.

Last month, one such product, outside of Morningstar coverage, was launched by Metrics Credit Partners.

Andrew Lockhart, managing partner of Metrics, notes that investors who rely on earning interest from savings are the biggest losers in the low interest rate environment, as banks slash their rates on cash accounts, term deposits and savings accounts.

"To top it off, in bond markets, investors are paying higher prices for declining yields, with Australian government bonds generating less than 2 per cent and corporate bond yields continuing to fall. Overseas, negative rates mean some investors are paying to own bonds.

"But by moving just slightly along the risk curve … investors can obtain reliable returns of between 4 and 10 per cent a year from the corporate loan market," Lockhart says.

Metrics was the first corporate loan lender to list and investment trust on the ASX in 2017, when it launched the IPO of its MCP Master Income Trust (ASX: MXT).

MXT targets a return of the RBA cash rate plus 3.25 per cent a year (net of fees) through the economic cycle, with income distributions intended to be paid monthly.

. Glenn Freeman is senior editor, Morningstar Australia.

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