As COVID-19 continues to exert its influence on the economy, investors may need to reconsider conventional attitudes to cash as a risk-mitigation tool.
For almost two years, the COVID-19 pandemic has been significantly impacting economies worldwide. In Australia, successive lockdowns have had a negative effect on Gross Domestic Product (GDP), suppressing confidence in business and consumers alike.
While government stimulus and support has been working to keep the economy afloat, uncertainty about the future remains. In times like these, investors often turn to assets that protect them from potential volatility and loss. This includes cash – which has traditionally offered stable returns and high liquidity and acted as a counter to higher-risk assets in a diversified portfolio.
However, in the current environment, cash faces some significant challenges. Low interest rates and the potential for higher inflation is not only limiting potential returns, but is possibly eroding gains also. As such, for cash-rich investors, it may be time to consider whether a traditional cash strategy is still capable of supporting long-term wealth goals.
Interest rates to stay low for some time yet
In March 2021, the Reserve Bank of Australia (RBA)disclaimer said it will not increase the cash rate until actual inflation is sustainably within the 2% - 3% target range. The RBA predicts this is unlikely to happen until 2024 at the earliest.
The cash rate is going to remain low for some time yet,” says ANZ Senior Economist Felicity Emmett. “That is something that the RBA has been very explicit about. It doesn’t expect to raise the cash rate until 2024. Now, it might end up being before that, but at this stage it seems unlikely to be increased before 2023.”
This means that money held in cash is unlikely to deliver a positive return, relative to inflation, for some time yet. In other words, cash investments will likely be going backwards in real terms over the next few years.
So why is the RBA wanting to keep rates so low? Its policy settings are aimed at encouraging investment that keeps the economy movingdisclaimer, while also helping homeowners keep debt manageable and avoiding sharp falls in the property marketdisclaimer. The government also has high levels of debt due to the stimulus measures it’s introduced to keep the economy afloat. By having low interest rates, it acts to support inflation, which has been below the RBA’s preferred band of between 2% and 3% for several years. Raising interest rates would limit the potential for inflation to grow further.
Emmett predicts inflation will need to be above 2% for at least a few consecutive quarters before the RBA considers raising interest rates.
"That means that anyone who is holding cash, is unlikely to see an improvement on the rates they're being offered for at least another year or so. That's a long time, especially when you consider relative returns on other assets."
Better times could be coming post-Delta lockdowns
Despite the recent challenges of the Delta outbreak, there is potentially good news on the horizon. In Australia, household savings have never been higher, the property market continues to boom, and debt is easier to manage due to low interest rates. In addition, the stock market recovery that was taking place before the Delta variant hit our shores provides some cause for optimism for the year ahead.
Emmett says once restrictions ease, consumers will likely spend more than they did prior to the lockdowns, providing a much-needed boost to the economy. “The household saving rate is very high; people now have a very large mass of deposits in the bank,” Emmett says.
“Houses are also worth nearly 20% more than a year ago so Australians are feeling wealthy and ready to spend. I think that puts the economy in a good position to rebound strongly and expand once restrictions are lifted. We expect growth next year to be somewhere in the order of about 5%, which is a very strong year.”
While the equity returns seen so far year-to-date are unlikely to be replicated, strong growth is typically supportive of risk assets. This economic backdrop could provide the potential for some risk assets to grind higher towards year-end.
What the current economy means for your cash
Before the pandemic, investors typically used cash to generate income and provide a safety net within a balanced or conservative portfolio. However, the current low interest rates – and potential growth elsewhere in the market – mean that cash in the bank is costing you money, once inflation and opportunity cost is factored in.
Because of this, those with large cash reserves should consider whether cash is still the right asset for achieving their diversification, income and liquidity goals. This may mean exploring other asset classes, like high yield debt, equity income and unlisted infrastructure to achieve the same results.
ANZ Private’s Head of Research and Governance, Ben McBride, says that investors should stay focused on their overall strategy.
“Most investors are aware they have to take a different look at what level of risk they're taking in their portfolios, whether that be market or liquidity risk,” he says. “It's important for investors not to go from one risk extreme to the other, and that they take a balanced approach.”