Are Interest Rates Really Going Down?

Many people are closely monitoring the Reserve Bank to see if there is any sign of a rate reduction. Even a small shift in interest rates could have a significant impact on the performance of mortgages, savings, and investments for everyday investors, homeowners and savers. It can be hard to distinguish between fact and speculation when inflation, economic growth and global market forces are all thrown into the mix.

Lisa Leong, ABC Radio Melbourne, invited investment expert Remo Greco to help her make sense of the changing economic climate, forecasts for interest rates, and investment strategies that are smart in these times. Together, they discussed how economic data influences Reserve Bank decisions, what signals to look for and how investors can adapt their portfolios in order to avoid uncertainty while still seeking out growth.

How Likely Is an Interest Rate Cut?

According to market statistics, there’s a 98% chance that the Reserve Bank of Australia (RBA) will cut interest rates at the upcoming meeting, making it almost a sure thing. The expected cut is likely to be a modest 0.25%, lowering the cash rate from 3.85% to approximately 3.6%. For borrowers, this is welcome news as it can ease mortgage repayments and borrowing costs.

But for investors, the picture is more complex. The economy’s current state means that interest rates are being trimmed carefully to stimulate growth without overheating inflation.

What Drives Rate Cuts?

The RBA’s mandate is to balance two key objectives: employment levels and inflation, as measured by the Consumer Price Index (CPI). Over the last few months, inflation has slowed down to around 2.5%, comfortably within the RBA’s target range of 2-3%. This is good news since runaway inflation can harm the economy.

At the same time, employment growth is slow but steady, complicated by fluctuating immigration patterns both in Australia and globally.

With inflation stabilising and employment rising slowly, the economy is growing at a modest pace. The RBA likely sees this as a signal to lower rates slightly to encourage consumer spending and economic activity without triggering inflation again.

What does this mean for consumer spending?

Interestingly, the spending patterns show a clear division between income groups. Luxury brands and high-end retailers are doing well, which suggests that wealthy consumers feel confident to buy premium products and experiences. This is due to factors like higher savings rates and investment gains. They also have access to credit.

In contrast, consumers with lower incomes tighten their budgets and cut back on non-essential items, opting to buy cheaper alternatives whenever possible. This group is feeling the pinch from increasing living costs such as rent, groceries, utilities and fuel. This uneven spending behaviour reflects the uneven impact on society of economic conditions. Some consumers are able to absorb shocks, while others have to prioritise necessities. Overall, consumer spending may appear to be stable, but what consumers are buying is changing.

The Impact on the Australian Dollar

When rates are cut, the Australian dollar is usually pushed down and becomes cheaper compared to other currencies. Investors often look for higher returns in other currencies when interest rates drop. This can cause the demand for currency to fall. Exchange rates are not influenced solely by domestic decisions, but also by interest rates and economic conditions overseas.

The Australian dollar, for example, may not move much against the USD, even if the rates at home are cut. Travellers heading to Europe could notice a completely different impact if the euro strengthens. It may become more expensive for them to visit. While a rate reduction can affect currency values, its actual impact is dependent on the global market conditions as well as how other major economies perform at the same time.

What Should Investors Do When Rates Are Falling?

Remo Greco warns investors not to panic or rush into locking in fixed income rates now. Professional market rates have actually been falling since last Christmas, months before the official rate cut, so the market has already priced in these expectations.

Instead, investors should:

• Look beyond headline rates. Advertised returns can be tempting but often hide fine print and risks beneath the surface.
• Understand what you’re really buying. Whether it’s government bonds, corporate bonds, or other income products, know the quality and safety of the underlying asset.
• Be cautious of reinvestment risk. For example, if you have a term deposit locked in, your rate is fixed until maturity, but when it matures, you may face lower rates.
• Consider securities that adjust with market rates. Products with variable returns linked to interest rates can help protect purchasing power if rates rise again.
  

What About New Investment Products Like RMBS?

Remo explained residential mortgage-backed securities (RMBS), a type of investment that pools home loans and sells slices of them as securities. These have traditionally been for institutional investors, but now some ETFs listed on the ASX allow retail investors to buy into RMBS.

While RMBS offer returns around 5%, they are generally backed by fairly secure home loans with conservative loan-to-value ratios. Unlike the US market before the 2008 financial crisis (portrayed in The Big Short), Australia’s housing market and lending rules are more stable, and borrowers can’t just walk away from mortgages without consequences, which lowers the risk of mass defaults.

How Can Share Market Investments Be Made With Falling Rates?

Remo recommends ETFs to those who are considering trading shares as an easy, diversified entry into the market. ETFs are a good choice for beginners because they allow them to spread their risk over a variety of companies, without having to choose individual stocks. While the share price is at an all-time high, this can cause some investors to be nervous. However, history shows that markets continue to rise even after reaching new peaks, as they tend to factor in future growth. High valuations do not always indicate a downturn in the market, especially when economic conditions are supportive.

Superhero, Moomoo, and other platforms can help beginners access ETFs or shares at relatively low cost. These platforms have user-friendly interfaces with lower fees. This makes it easier for investors to build a portfolio without having to spend large amounts of money. New investors can manage their risk better by focusing on low-cost, diversified investments.

Should you be worried about a market crash?

The share market experiences corrections – drops of about 20% – every few years. However, major crashes such as the Global Financial Crisis in 2008 are rare. As seen in the COVID-19 era, governments and central banks have become more proactive about stabilising the markets during times of downturn. Short-term crashes are less of a concern for long-term investors because markets recover and grow over a period of 20 years. Focusing on the long-term and having a diverse portfolio will help investors to ride out the volatility and profit from an overall upward trend in markets.

Interest Rates vs. Inflation: What Retirees Should Know

The risk of inflation is a major concern for retirees or those on fixed incomes. The real value of your savings can decrease over time if inflation is higher than the interest you earn on fixed-income investments like government bonds or term deposits. Even if the balance of the account remains the same or increases slightly, retirees can still see their purchasing power decline as daily expenses such as groceries, utilities and healthcare increase in price.

Remo suggests that investors consider investments with returns that adjust to market rates, because inflation has become more volatile in recent years. These investments help to preserve purchasing power because they offer returns that adjust according to the changing economic conditions. They do not remain fixed in an environment of low interest rates. Selecting assets that are able to adapt to changes in the market can help retirees protect their savings from inflation and still generate a steady income.

Final Thoughts

Interest rate cuts are nearly certain, reflecting a cautious but positive economic outlook. For investors, the key takeaway is to look beyond headline figures, understand the underlying risks and assets of any investment, and adopt a long-term perspective. Whether you’re new to investing or seasoned, the evolving interest rate environment calls for careful strategy and thoughtful decision-making.

If you want to learn more about navigating today’s market or have specific questions, keep an eye out for more insights from Remo Greco and other experts. And remember to invest wisely, and always consider your personal financial circumstances.

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