While the Melbourne Cup and the US election have drawn people’s attention this week, the RBA meeting on Tuesday was a significant market event that will have big implications on many asset classes.
Most of what was announced was largely expected so there was never going to be a big market response, but it’s worth discussing the big changes in detail.
- The RBA cut the cash rate from 25 basis points to 10 basis points. The motivation behind this is a little interesting in my view. None of the banks have passed this on to mortgaged homeowners, and this will largely impact savers (either with cash on deposit or floating rate debt instruments). Phillip Lowe has talked about bank customers asking their banks for reduced mortgages or shopping around for a better rate, but the bigger issue he raised was the desire of the RBA to keep a lid on the currency. In a world where most governments are in a race to drop interest rates as far as possible, the local currency is at risk of being flooded which would have a big negative impact on any export-aided recovery. A lower AUD is a big benefit for exports and the RBA has made it clear that this is a priority.
- The RBA also announced that it would begin $100bn worth of quantitative easing. This will target Aussie government bonds with maturities of between five and ten years which will keep a lid on medium to long-term interest rates. This too will have an impact on the currency as cash floods the system.
Some of the key takeaways from the changes discussed below are that the environment for equities remains very positive and savers are forced into riskier investments to beat inflation, and extra cash in the system needs to find a home. Quantitative easing has been used extensively by governments in the wake of the GFC and early on in the pandemic, but it is a big step-change for the RBA. Personally, I think there are good enough signs of a strong recovery domestically that this may be overkill but I would definitely prefer monetary and fiscal policy to overshoot than undershoot.
This will also have an impact on the listed hybrid security market which we do have some exposure to through our Income Strategy. With interest rates set to remain low for some time, we are actively working on increasing the exposure to marginally riskier names in exchange for better returns, and we will have some updates on this in the coming weeks.
I have also discussed Mainstream’s Capital Stable Separately Managed Account product (which uses Rivkin’s Low Volatility strategy) a bit recently as an alternative for those members unhappy with the returns on offer either on deposit or through the listed hybrids. The new RBA policies should have a good long-term impact on Capital Stable with 50% of the portfolio held in $USD, and our expectation is that the long-term average of around 6% per annum should be easily maintained in the current environment. This strategy comes with tax benefits as well with the returns being generated by long-term capital gains (which come with a discount of 50% of the total gain) compared to the income generated by hybrids or term deposits which are fully taxable in the year they are paid.
If you are looking for investment alternatives for your cash that might provide better returns than current deposit or hybrid securities, but with less volatility than equities this is a product that may suit. You can read more about this product in the recent update we have provided to existing investors here.
