Market Watch: Lower interest rates - should we cheer or jeer?

Reserve Bank of NZ Governor Adrian Orr. Photo / File

COMMENT:

With New Zealand's Reserve Bank following the US Federal Reserve in stepping back from a path of rate hikes there are good reasons for stock market investors to cheer.

Interest rates look like being lower for longer and that has underpinned a strong rebound in markets.

The NZX-50 soared to new heights on after the Reserve Bank statement on Wednesday and is now up more than 10 per cent in the year to date.

But lower rates also come with a downside for markets, says Pie Funds chief executive Mike Taylor.

Last week Wall Street was rattled and took a sharp dive on news that the Treasury yield curve had inverted - a sign that usually points to impending recession.

In short, interest rates – already low - are expected to stay low for longer and possibly even fall further.

While that should be broadly good news for equity markets, Wall Street's recent reaction shows it has done little to inspire confidence in the global economy.

Last week the yield on the 10-year US Treasury note fell below the rate for the three-year bill.

That means bond investors get paid more to hold shorter-term US government debt than they do for holding it for a longer term - a sign of pessimism in the economic future.

"Why that is important for markets, is because the yield curve has predicted every recession since World War II," Taylor said.

However, based on past experience, the process could still take some time to play out.

There was an old investment adage that the bond market was more intelligent than the stock market, Taylor said.

But history suggested that a recession could take up to two more years to emerge.

In that sense this shouldn't be a cause for panic, he said.

The US economic expansion is already in a late stage and - assuming it makes it to the end of June - it will become the longest in the nations history.

One of the big differences this time has been that central banks have been a lot more proactive, Taylor said.

"In previous cycles central banks have been trying to keep a lid on inflation and have been fast to hike rates," he said.

The key for investors was going to be staying focused on the data, Taylor said.

But what the data was showing was that the global economy was slowing.

"Manufacturing numbers all around the world are slowing, earnings growth is slowing. So central banks are doing this for a reason they are not just doing it to be kind to investors."

The action of the central banks now had the potential to make this a more gradual slowdown than we have seen in the past, Taylor said.

That sort of scenario would likely mean more volatility in markets but would at least avoid a major crash.

Investors will need to keep an eye on real earning and valuations, he said.

But the lower rates were likely to mean more money coming back to markets.

"Global pension funds have targeted rates of seven to seven and half per cent. They are not going to get that from US Treasuries on New Zealand Government bonds."