Neil Birrell, Premier Miton’s Chief Investment Officer, wonders if cash will remain attractive as central banks pause, or maybe halt, their interest rate increases and if other investments are now taking its place.
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
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The status quo
Cash has become an increasingly popular place to invest money over the last 2 years, as interest rates have risen back to levels not seen since 2007, before the global financial crisis. This has been accompanied by poor returns from bonds, which became unattractive relative to cash, so their prices fell, along with large swaths of the stock (equity) market as well as other types of assets, such as property. It has been unsurprising that the attraction of cash deposit accounts has been grabbed by many.
Why was cash crowned?
The reason for the rise in interest rates is clear; inflation had to be beaten and the most direct way to do that is to put up interest rates to slow economic growth and it has worked! As it stands today, we cannot be certain just how well it has worked, as it takes many months, maybe over 12 months, for the full effect of a change in interest rates to impact. It might be all the increases we have had so far are enough, or maybe more are needed. However, the current signs are good.
In the UK, inflation has fallen back to the lowest level in 2 years, retail sales for October were sharply down, by more than expected and the figures for September were revised down as well. The housing market is under some stress and the employment data is not very encouraging.
It is worth looking elsewhere to see what is happening as well, economies around the world are very interlinked. The US is the biggest and most important economy, it is a similar picture there, inflation is moderating nicely. However, the economy is slowing at a gentle pace.
Why would the crown slip?
The data we are seeing is causing central banks such as the Bank of England, US Federal Reserve and the European Central Bank to pause their interest rate increases. This is because they are of the view that inflation is moderating, and they will be concerned that further increases could lead to a sharp economic slowdown or recession. As I look at the likelihood of what may happen, my view would be that we are probably at the peak level of interest rates and that the US economy will slow but avoid recession and the UK may go into recession, although not a deep one.
If that is the case, then the deposit rates available at the bank have peaked as well. The next question is how long will interest rates stay at this level before falling? That will depend on how inflation slows and other economic data. It had been assumed that interest rates would stay elevated and not start falling until, maybe the end of next year.
But events are moving quickly and financial markets have shifted expectations for interest rates to start falling much earlier than previously expected, possibly before June next year, that’s only 6 or 7 months away. It may be that inflation does not fall as hoped, in which case that doesn’t come to pass or it might be that we go into recession, which could mean that rates fall faster and further, but recession brings other problems as well; unemployment rises and company profits fall, amongst others.
Right here, right now
It would be reasonable to expect those bonds and equities that did badly as interest rates rose, to recover as interest rates are expected to fall; that is what is happening at present, and they are recovering sharply in many cases. It is unlikely to continue in a straight line and events may unfold differently.
If I look at different types of asset today and think about what returns may be possible over the next 2 to 3 years, I can see is that the return on cash is likely to fall, not back to near zero as we had for many previous years, but meaningfully lower. If I look at bond markets, there are parts that have fallen to levels that now offer attractive returns with much lower risk. As interest rates fall, returns should improve. There are good companies on the stock market whose share prices have fallen, but whose underlying business is doing very well; as interest rates peak, they should come back into favour. It is a similar story for property companies and other asset classes such as renewable energy and energy storage.
I could build a portfolio of assets that should benefit from the changing economic and financial market backdrop, where I believe returns will be improving and rewarding, just as the return from cash deposits could be at its peak and the point when its starts falling is in sight.
This was always going to be the case, it was just when the risk / potential reward profile of cash versus riskier asset classes would change.
Clearly, I could be wrong in this view and trying to time the change perfectly is more down to luck than judgement, but, to some extent it’s what financial markets are doing already.
