Interest rates at 1%, what does this mean for markets and investors?
12 August 2019
Last week the Reserve Bank of New Zealand (RBNZ) surprised the market by cutting the official cash rate (OCR) by 0.5% to a new all-time low of 1%. Most economists were expecting this level to be reached this year, but not in one go, and now the natural question is whether this will go even lower in the coming months.
The impact of record low interest rates has certainly been evident in both fixed interest and equity markets, with large capital gains for investors in both. However this also means that future returns will be lower, well at least when interest rates stop falling.
At the moment the 10 year government bond yield in New Zealand is 1.1%, which is only slightly higher than the new OCR rate of 1%. This seems like very low extra compensation for a 10 year investment but could turn out to be an attractive yield 12 months from now if the OCR is at 0% or even negative as we have seen in other countries.
The same argument could be made for any positive yielding investment but it is important to remember that there are limits to how far interest rates can fall. Investing purely on this basis has its risks, especially if interest rates were to start rising again. The current dilemma for fixed interest investors is the trade-off between locking in the very low interest rates on offer now for an extended period of time or having some shorter term investments that could potentially be reinvested at higher interest rates in a year or two from now.
We think the best approach is to have a laddered portfolio with a mix of different maturities to allow flexibility to re-invest as interest rates change. This is the approach we take at QuayStreet. Our Fixed Interest and Income Funds allows the Funds to have some benefit from falling interest rates but also the ability to invest at higher interest rates in the future if this was to occur.
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