Rate cuts are coming, what should investors do?

The Official Cash Rate (OCR) will soon be headed lower, and this will have important implications for savers, borrowers and investors.

Financial markets have taken a bolder view than most economists, and they now see at least two (but possibly three) 0.25 per cent cuts before the end of the year.

A move in October or November seems assured, while there’s half a chance the Reserve Bank might take a more proactive approach and cut the OCR next month.

Its most recent estimate of the short-term neutral OCR (the level where it’s not speeding up or slowing down the economy) is just under four per cent.

That means there’s plenty of scope to begin the easing process soon, while keeping policy settings restrictive (albeit to a slightly lesser extent).

It’s equally important to note that it can take several months for policy changes to begin filtering through to the economy.

If the Reserve Bank wanted to provide some relief in the first half of 2025, it would need to make a move soon.

Whether it happens in three weeks or three months, the upshot is that the monetary policy landscape is about to change markedly.

One group who shouldn’t ignore this are the income focused investors sitting back and enjoying highly attractive term deposit rates.

They’ve had a great run, but the clock is ticking. Loudly.

If this group is too complacent, they’ll not only miss opportunities elsewhere but face hefty falls in income.

Six-month term deposit rates are sitting at about six per cent, the highest in 15 years.

If market forecasts for the OCR are correct, these will fall to 4.5 per cent within 12 months and could start with a three a year after that.

That equates to a 25 per cent fall in income over one year, and a 35 per cent decline from current levels within two years.

Savvy investors should act soon, rather than sit on their hands.

There are still opportunities to lock in reasonable yields from high-quality fixed income securities (or funds) with maturities that stretch out years, rather than months.

The local sharemarket, out of favour in recent years amidst high interest rates, has also started attracting more attention.

It’s rallied almost six per cent in July so far, which puts it on track for the strongest monthly gain since April 2020 (when it was rebounding from COVID).

While indices in the US, UK, Europe, Australia and Japan have all hit new record highs this year, New Zealand is still 18 per cent below its January 2021 peak (excluding dividends).

Our market isn’t as frothy or highly priced as some others, while investor sentiment has been much more subdued.

That isn’t surprising, given the NZX is more sensitive to changes in interest rates than many global peers.

Sectors that dominate our market tend to perform well when rates are stable or falling, and suffer when monetary policy is tightening.

The prospect of OCR cuts could mark an important turning point for domestic shares, in spite of a  fragile economic backdrop.

Many of our listed companies are stable, resilient businesses paying reliable dividends that will look increasingly attractive as interest rates steadily decline.

Even some of the beaten up, more challenged parts of the market could start to be viewed more favourably, despite the lacklustre earnings releases we’re all expecting in August.

Share prices look ahead, which is why they’ve been in the doldrums these last three years.

Investors have been correctly anticipating the recessionary conditions and economic malaise we’re in the depths of right now.

It’ll be the same on the way up. The market won’t wait for a recovery to be upon us, it’ll move well ahead of that.

Investors would be wise to do the same, and start positioning now for an extended period of declining interest rates.

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