With rates at their lowest level on record and forecast to go even lower savers are no longer satisfied with term deposit rates.
On average banks are offering six month term deposits at an annual rate of 1.85 per cent. This is only marginally above the most recent inflation reading of 1.3 per cent, meaning investors are receiving an average return of 0.6 of a percentage point before tax.
Not too long ago, savers could comfortably earn a return higher than inflation without having to go past term deposits, those days are gone. The Reserve Bank of Australia (RBA) cash rate is now 1.25 per cent following a cut in June and the market is pricing in two more rate cuts by the end of 2019, which would bring the cash rate down to 0.75 of a percentage point.
If the cash rate does fall that low, term deposit returns would likely fall below the inflation rate, creating a negative return for investors.
While some savers are worrying about the low cash rate, savvy investors are asking the right questions to find alternatives. For the risk adverse investors this often leads to a conversation around investment grade corporate bonds.
Corporate bonds are just corporate debt. Global corporations borrow money by issuing bonds to the wholesale market and in return they pay debt holders a fixed or floating interest payment referred to as a coupon.
Conservative investors typically focus on Investment Grade (IG) bonds. These carry slightly more risk then a term deposit but a lot less risk than equities. Bond prices have been moving higher across the board and this is a reflection of increased expectations for interest rate cuts.
At Citi we have seen a 273 per cent increase in bond volumes over the last 12 months and we expect demand to continue to increase. Investors can expect a return of up to *5 per cent a year at todays bond prices; this is attractive for many high net wealth (HNW) investors, especially as cash rates continue to decline to new lows.
Bond investors are not chasing high returns from high risk asset classes like equities and instead are looking for stability and reliable income. Bonds are stable during times of uncertainty which is appealing for many investors. Some investors are looking for higher returns and Citi has alternative fixed income solutions for them as well.
Citi clients are invested in high quality bonds from over 500 different issuers around the world and in multiple currencies. There are a huge variety of bonds to choose from and investors can choose a bond that matches with their view on interest rates. Fixed rate bonds are currently the most popular as these pay a fixed interest rate regardless how low rates go. Floating bonds on the other hand offer a variable return that move inline with a set benchmark; these tend to be more popular when rates are expected to move higher.
The most recent inflation reading from the RBA showed inflation as stagnant with 0.0 per cent growth in the March quarter and 1.3 per cent growth for the last 12 months, which is well below the RBA target of 2- 3 per cent. This means that the RBA has room to cut rates to boost growth.
Lower interest rates mean borrowers have more money to spend, which can create a ripple effect of increased spending throughout the economy.
In the most recent RBA statement, the board has indicated that they will be paying close attention to developments in the labor market at its upcoming meetings to determine how deep it will cut rates.
Average term deposit rates are expected to decline later this year. Many HNW investors are purchasing bonds today so that they can lock in higher yields now through fixed bonds. This makes sense as bond yields will also decrease if there are further interest rate cuts.
Peter Moussa is an investment specialist at Citi
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