Unless you live under a rock, you’ll know the Reserve Bank of Australia (RBA) cut the cash rate yesterday. After knocking 0.25% off the rate, it now sits at 1.50%.
This is a historical low for the cash rate. And it’s a sorry sign that the Aussie economy is anything but resilient right now. But if you thought this was the end of it, here’s the inside track — it’s not.
When the debt crisis hit back in 2008/09, Australia was seen as resilient to the turmoil in markets. Yes our stock market did fall and there were some speed bumps. But overall the economy held up reasonably well.
The problem however is it didn’t really hold up that well. We just were starting from a higher base than the rest of the world. Now, we’re catching up. Aussie rates are heading to the levels of our global counterparts.
In other words, Australia is heading into the depths of central bank despair.
How low can you go?
Central banks all over the world have become ineffective. Cash rates globally are so low that there’s nowhere else to go. The Bank of Japan has rates at 0%. The European Central Bank also has rates at 0%.
The Bank of England has rates at just 0.5%. Yet it’s almost a given that on Thursday and they’ll be at 0.25%. And with manufacturing and construction seizing up here, in my view they will be at 0% this year.
The US isn’t much better. Although they have decided they need to increase rates. The problem is there’s no real justification for increasing rates. The US economy isn’t all that robust. They’ve got a debt addiction to rival anyone.
The US is planted, like the BoE, at 0.5%, after coming off 0.25% for the last seven years. They do want to increase those rates though.
The reason they want to increase rates? So they can decrease them again. They know there’s trouble coming ahead, but you can’t do much from a 0.25% basis — the only option is negative rates.
So they’re performing a ‘pre-emptive strike’ and raising rates now, before the turmoil, so later on they’ve got some ammunition in the bag.
The only problem is they’ve now gone soft on the idea of higher rates, because of the damage it could do to the current economy. Catch 22 if I’ve ever seen one.
This is central banks playing with a big economic yo-yo. But if you’ve ever used a yo-yo before, you’ll know eventually it bottoms out and stops spinning.
That’s about where we are now. There’s no more ‘yo’ or ‘yo’ left. Now global economies are just a useless wheel dangling by a thread.
The RBA is as ineffective as the lot of them. The recent cut should have seen the Aussie dollar fall. In falling it would help make our commodities-focused economy more price competitive. Except the reverse happened. The Aussie dollar strengthened against the USD. Oh no Mr. Stevens, that wasn’t supposed to happen.
So what comes next? What does this rate cut really mean for you? How is it going to impact your day-to-day life? What will it do you your investments? How will your cash perform? Will your mortgage rate fall? Will your stocks crash in value?
Well the simple answer to those questions (respectively) is; not much, very little, barely at all, nothing, actually get better, no and no.
Let’s tackle them one by one so you’re pretty clear as to what to expect next after this worrying RBA rate cut.
How does the RBA rate cut impact you?
First let’s look at your cash holdings. You would think that with a rate cut your savings would suffer. But that’s not the case. Amazingly, the banks have decided to increase the interest paid on term deposits.
With inflation at 1% and a CBA one-year term deposit at 3%, your cash can do surprisingly well for you. In fact you’d almost be crazy not to stick some of your cash into a one-year term deposit, if you don’t have any other plans for it over the next 12 months.
So cash is doing actually pretty well — it’s even beating the overall stock market. Year on year the ASX All Ordinaries index is down 0.20%. Virtually zero return in 12 months. In this case cash has been king!
Still, you’ve probably got investments in the market, not just the All Ords index — at least I hope you’re not just invested in the index…
What impact will a rate cut have on your stocks? Not much, to be honest. A rate cut will drag down overall sentiment in the market. And some investors will take money out of the market due to fear and uncertainty (and probably dump it into cash). But if you can find good companies on the ASX that are still growing, building revenues, profits and expanding even in this market, then you can still make sizeable market returns.
What I would say on that is that the big end of town, blue chip stocks, tend to feel the pain of this more than smaller companies outside the ASX 200 or ASX 300. For instance Data#3 Ltd [ASX:DTL], a relatively small $201 million company, was up 4.38% yesterday.
Did they care about the rate cut? No. Have they given two hoots about the tough economic situation this year, or even the election? No. The company is up 23.58% year to date.
If you can sniff out great companies, then a rate cut, an election or any kind of political skulduggery mean nothing. Great companies will perform in all kinds of markets.
Cheap money doesn’t stay cheap forever
Now, how about that mortgage you’ve got? Well that’s fractionally cheaper thanks to a rate cut. Not fully cheaper. As if the banks would pass it on in full. Don’t forget their responsibility is to shareholders, and this is a great chance to just eek out a little more profit. They need it too, because everywhere else in the world banks are faltering.
Maybe they should take a little more. How would that go down? That might be the case if the RBA cuts rates again, and again you know. Imagine another 1% worth of RBA rate cuts. Sounds good in theory for your mortgage…unless the banks don’t pass it on at all.
And then if things settle, even get better and rates rise. Well isn’t that going to open a can of worms as the banks bump up rates on the upside? Don’t be fooled by a low cash rate when it comes to mortgages.
This isn’t going to avert a housing crisis. If anything it’s going to pull suckers in and make it worse. Cheap money doesn’t stay cheap forever. And when it’s no longer cheap, there’s going to be a major affordability crisis. Or if the economy continues to falter and unemployment creeps up, insolvencies continue to rise and mortgage defaults bump up, Australia still could be facing a catastrophic housing crash.
Still, today, tomorrow, you’ll still wake up. The crumby morning TV shows will still make your ears bleed. You’ll still eat breakfast, lunch and dinner. You’ll still do it again the day after. A rate cut makes headlines and sounds big, but if you don’t let it fool you, it’s not going to change your day-to-day life.
Your cash can work better for you. If you’re smart, your stocks can work better for you. And if you don’t owe more than you’re worth, then you’ll always have somewhere to call home.
If you know how to play the game (and it’s not that hard I might add, if you’re smart about it) then all the brouhaha means little to you at the end of the day.
So as the Brits say, ‘keep calm and carry on’.