How will the US rate cut impact Australian Stocks?

One of the most debated topics in the financial markets around the world is the US Federal Reserve rate cut and how it resonates far and beyond the fringes of the American economy, including Australian stocks. It is a ripple effect where all sectors get affected. In this article, we discuss how this US rate cut will affect Australian equities, which sectors can potentially gain from this and where investors need to be cautious.

 

Understanding the US Fed rate cut: Why Investors Should Care

A rate cut is the lowering by the central bank of the interest rate at which it lends to commercial banks, making it cheaper for people to borrow money. Whenever the US Federal Reserve cuts interest rates, this is usually to boost the US economy through borrowing and investment. The Fed’s moves are being watched closely by financial analysts this week as markets already expect a cut.

While the US rate cut directly impacts American businesses and consumers, it trickles to affect the rest of the world since financial markets around the globe are interlinked. The Australian market, especially the stocks (ASX), will consequently feel the impact of this decision.

 

How a US Federal Rate Cut Impacts Australian Stocks

An easing of US Federal Reserve rates normally spills over into higher global liquidity, which is usually positive for equity markets. There are, however, a lot of channels through which the US rate cut will flow into the Australian stock market:

Currency Exchange Movements

Some of the direct effects include movements in currency exchange rates. A decrease in US interest rates typically results in the weakening of the US dollar but strengthens the Australian dollar. It is to the detriment of some Australian exporters as export goods become relatively costlier abroad. The mining and agriculture sectors, among others, are significantly affected by this fact.

Commodity Prices Fluctuations

Since Australia exports commodities, any US monetary policy shift that tends to alter the way the world adjusts commodity prices will play out locally. A low interest rate could mean that there’s a higher price on commodities due to the high demand for such and would be beneficial to any miner operating from Australia, especially those concerned with exportation, such as iron ore, gold, and coal.

Investor Sentiment and Risk Appetite

Investor sentiment and risk appetite typically rise with a falling interest rate. A fall in the interest rate of the US will lead to reduced yields on safe assets, such as bonds. This will propel investors into seeking the higher returns offered by the more risky assets; which consist of equities. This may in turn mobilize foreign capital into the Australian stock market as price tends to go upwards in all directions.

Equity Market Response Over Time

Over the last decade, the equity markets of the world, from the ASX to the NYSE, have tended to rise whenever the central banks of the world lowered interest rates. A US rate cut might be able to keep that going, probably most powerfully in growth-sensitive sectors like technology and healthcare.

 

Winners and Losers: Which Australian Sectors Will Thrive or Dive After a US Fed rate cut?

A rate cut will generally boost stock markets; sector effects will vary. Now, here’s a sector-by-sector analysis of which could gain or suffer from the US rate cut:

Winners:

• Mining and Resources: Commodity-linked sectors may benefit from an increase in global demand, which would push up commodity prices. BHP and Rio Tinto, companies that are concerned with iron ore and copper, heavily tied to global industrial activity, stand to benefit from stronger demand.
• Consumer Discretionary: With market liquidity building up and sentiment improving, consumers are most likely to spend more. This will work out well for the consumer discretionary sector-that will include retail companies, entertainment, and hospitality stocks.
• Technology and Health Care: These are two of the biggest industries that have seen tremendous growth over the last decade. All the reasons are there to believe that the low-interest atmosphere will continue to provide support and opportunities for expansion and novelty for tech and healthcare stocks. With more liquidity globally in Australia, Aussie investors seeking long-term growth should still see overseas markets increase investment in overseas markets for Aussie tech and healthcare stocks.

Losers:

• Financials: Financial stocks are painful during low-interest-rate environments where the decline in net interest margins hurts. Australian banks have been fighting low interest rates for years now and will suffer more margin compression to find it less profitable.
• Exporters: A rising Australian dollar hurts exporters which include farming companies and manufacturers. Since the goods become costlier to foreign buyers, the competitiveness of the products goes down along with possible revenues going down.

 

Historical US Federal Rate Cuts data vs ASX Performance

Historically, the Australian stock market has tended to track at least a short-term positive direction whenever the US Federal Reserve has cut rates. For instance, in 2019, the Fed’s rate cuts were followed by a surge in the ASX 200 where the index went past 10% rises in months after that.

Importantly, while these short-term benefits sometimes translate into long-term turmoil, investors may respond positively initially but end up facing winds head-on in the case of deteriorating economic conditions or deeper underlying issues the US rate cuts signal in the world economy.

 

Past Statistics Associated with Rate Cuts

When the Fed dropped the rates by 0.25% in July 2019, the ASX jumped about 2.7% the following week.

During the global financial crisis of 2008, the US rate cuts led the ASX to shoot up by nearly 15% within the next six months.

These stats are indicative, yet also reflect the delicate complexities of global markets. Single-term rate cuts may produce short-term rallies but require scrutiny of patterns over the long term.

 

Risks to Watch Out For

While the given pros of Australian stocks in case of a US interest rate cut are numerous, there also exist some risks investors must look for:

• Market Volatility: The rate cuts generate short-term shots up but may also represent hidden economic weaknesses. Hence investors must watch for any volatility in the markets especially when the rest of the world’s growth slows.
• Overvaluation Concerns: If the cuts in the US spur a stock market rally, then some sectors may turn out overvalued, and companies could find it difficult to justify high valuations if earnings do not match up.
• Dividend Yields: For the income-seeking investor, the cut in rates into the dividend yield is another consideration. The declines in interest rates are mirrored by declining yields on dividend-paying stocks, especially in the financial and real estate space.

 

Investment Strategies After US Federal Rate Cut

To negotiate the effects of a US rate cut for Australian stocks, an investor should consider the following:

• Diversification: The effective impact of a US rate cut in different sectors differs as it has positive or negative sides on the same score. Investors would look to diversify the portfolio with exposed sectors at a balance to other sectors in the technology resources and consumer discretionary side.
• Growth sectors: Healthcare and technology will likely do well in a low-interest-rate scenario, providing better returns than traditional sectors such as financials.
• Tune in to global trends: With the US economy increasingly turning out to be a driving force in global markets, global trends in commodities and fluctuations in currency will form a key focus for investors seeking to exploit this rate cut.
• Be cautious with Financials: As the rates are falling, one needs to be cautious in assessing the effects that fall on financial stocks. Investors may want to avoid overexposure to banks and financials that could feel the pain from compressed margins.

 

What Investors Need to Know

The US rate cut this week is going to have a deep impact on Australian stocks. One would expect that while particular sectors like mining, consumer discretionary, and technology will do well, financials and exporters will struggle. Investors should look at the move balanced with historical trends, sectoral impacts, and potential risks. Diversification coupled with an emphasis on growth stocks with monitoring of global trends will remain very relevant in a changing landscape post the US Federal Reserve decision.

An understanding of the broader market dynamics and positioning portfolios post-considering rate cuts environment will enable informed decisions by Australian investors.

 

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