Over the next few months, we’ll be fleshing out some of the approaches our investors are considering as they build their portfolios in Hatch. Might as well learn from the people who actually use the platform, right? This month we’re looking at the global interest rate environment and how it influences our investor's decisions.
What’s a global interest rate environment, anyway?
Alright, let’s get back to basics. Central Banks set cash rates and these cash rates dictate the rates at which retail banks borrow money from the Central Bank. Twist! Then the rates that retail banks get from the Central Bank dictate the rates they give to people they borrow from (like you with all of your savings accounts and term deposits) and who they lend to (like you with your mortgages and credit cards). Still with me? Good. We’re just getting started. Let’s put this into something more tangible.
Back in June 2008, when New Zealand’s cash rate was 8.25%, the 6-month term deposit was an average of 8.45 per cent, and the floating home loan rate was 10.69 per cent. Fast forward 11 years to today and our official cash rate is 1.5%. *Cough* Savers are lucky if they’re getting 3% on their 6-month term deposit, while homeowners are paying mortgage rates at below 4%.
Investors are a savvy bunch, and if they can get low-risk high returns, they’ll snap up the opportunity. High interest rate environments, as we had in 2008, created safer alternatives for investors by way of high returns from savings accounts and investments in bonds (a mechanism where an investor can lend an institution money in return for an agreed interest rate). During these periods, money flows from traditionally riskier assets like stocks, into safer assets like savings and bonds.
The lowdown on low interest rate environments
Now, low interest rate environments, like the one we have today, generally have the opposite effect. Money flows from safer assets into riskier assets. Why? Because investors are looking for that sweet spot: their desired rate of return and that 2% premium savings rate offered by the banks just ain't cutting the mustard. The laws of supply and demand suggest that if demand is high prices go up. So low interest rates have generally seen more people investing in stocks, pushing sharemarket prices up.
Looking for the right signs
Investors look for signals of future movement in government bond interest rates to get a jump on future movements in equity markets.
Governments are the biggest producers in many economies; they build roads, look after the elderly and those who can’t fend for themselves. They fund the police, administer the tax system, and pay politicians. They can afford all of this by taxing citizens, printing money, and by borrowing money from investors.
To invest in the government, you get yourself a Government Bond. You give your money to them, and they promise to return a fixed amount every year for the lifespan of your investment (and your money back at the end of the agreed time period).
That fixed amount is what investors care about - it’s known as the bond's yield. It’s more than just a rate of return on a government bond - it tells the story of future equity returns.
Party in the USA
Even though economic signs in the States remain positive, Trump’s Trade Wars have had investors looking over their shoulders to safety. The Federal Reserve (USA’s Central Bank) had provided some hope of a safe-haven for investors. They were happily increasing the rates that had been slashed to 0.25% in December of 2008 after the global financial crisis. After 9 rate hikes from 2016 through 2018, the Fed landed on a cash band of between 2.25 and 2.5% which it has held now for a few months.
However, some analysts are now predicting there will be rate cuts as early as this year. A rate cut is a confirmation that the US economy, and its borrowers, can't handle the increasing interest rate burden and is entering an early downturn.
The threat of cutting from an already low starting point(2.25-2.5%) is seeing investors hold in an equity bull market that’s lasted for over a decade.
What you can do
Now, you know we’re not in the business of telling you how to invest. Do the research. Look at what the Central Bank is up to. Watch the signs. And then do something. Hatch gives you access to the world’s largest, most liquid share markets, but it’s up to you to take action.