Here Come the Rate Cuts

Includes: DIA, QQQ, SPY
by: Fat Prophets

The Fed started proceedings with a 50 point cut last week, followed early this week by the RBA with a 75 point cut.  Today, the ECB will chime in with 50 points and an hour later the BOE will deliver. The BOE may even go 1%.

The last time the BOE moved cash rates by 1% (as a consequence of the economy), was in the early 1970’s.  All is not well in the UK and that’s an understatement. 

However, spare a thought for the Spaniards. Typically when it comes to real estate they have been a nation of renters. Then in the late 1990’s and 2000’s they started to accumulate.  Now they are walking into Spanish banks and dropping the keys on the counter and walking out.  The collapse of UK travel agent XL (ex sponsor of West Ham) sums up the party scene at Ibiza.

There is a consensus that the world is heading towards a period where interest rates are going to be close to zero.  Some countries have more in their cash rates which will turn out to be very valuable in the coming landscape.

(click to enlarge above image)

As cash rates fall further and further, the deflation scaremongers get worried.  For investors in the medium term a near zero cash rate is disturbing.  What is suggests is, (for those who can access it) is a simple tenet;

I am happy to lend you money for nothing so long as you pay it back.

Forget about paying me interest just pay me my money back.

And that’s the poignant point: money for nothing.  Near zero interest rates are, a reflection not only of supply but of demand. 

If you cannot get funds (like banks) at the moment then this is a supply side issue.  This is why the Central banks are lowering interest rates; they desperately hope that by lowering the cost of cash, the cost of borrowing will be lowered which will allow banks to borrow money.

However, as the previous paragraph alludes, this may not happen because people are scared they won’t get their money back.  Forget about the interest rate.  

In time, faced with the economic predictions of the global economy, one may well argue that the demand for money will eventually wane.  Demand for money is largely a function of the two major reasons people borrow money; to buy property and shares.  Currently (and possibly for the future) these two assets won't yield a positive return resulting in a pointless exercise as far a borrowing money is concerned.

That’s the deflation scaremonger scenario, and has been the status quo in Japan for many years.

  1. The government knows they must get the cash back into the market quickly.
  2. Banks must then lend to each other and spreads must fall. 
  3. Then the stock markets of the world must recover.
  4. Allowing interest rates to move back up.

The longer it takes for the above process to happen, the greater the probability that interest rates won’t move up at all. It’s not a tautology, rather a function of zero interest rates.

If the market does not go up then the demand for money will be destroyed thanks to deflation.  It’s a tricky game.