“Interest rates act like gravity on assets,” legendary investor Warren Buffett is said to have said. What he means by this: If interest rates are high, it pushes down the valuations of all asset classes. If they fall, this justifies a higher valuation and the prices of the assets rise.
We have now been in a rate cutting cycle since June of this year. The European central bank has already lowered the key interest rate three times this year – it is currently 3.25 percent. But what happens if interest rates fall? What should investors prepare for?
Savers have to expect falling interest rates
First of all, the key interest rate has an impact on short-term interest rates. “Savers who have their money in daily accounts or want to invest it as a fixed-term deposit must therefore expect falling interest rates,” says Manfred Rath from KSW Vermögensverwaltung in Nuremberg. In fact, the interest rate for fixed-term deposits has already fallen at most credit institutions – from over four percent at its peak to under three percent.
And even if you invest your money at three percent, you won’t have much joy. “Fixed-term deposits only last for a certain period of time, often just one year,” says Franz Kaim from Kidron Vermögensverwaltung in Stuttgart. “But today you have to expect that the interest rates will be even lower after a year.”
Tip: Secure the current interest rates in the long term
The experts therefore recommend securing the currently attractive interest rates for the longer term. Fixed-interest securities offer one possibility. The idea behind it: With bonds, the investor receives the coupon over the entire term. “If you buy a ten-year bond, you will receive interest for ten years,” explains Rath.
The risk: that the issuer will experience payment difficulties. “This cannot be ruled out, especially in a difficult economic environment like we currently have,” says Kaim. “I would therefore rely on good credit ratings, i.e. corporate bonds from the investment grade range, but with a longer term.” After all, bonds with a longer term also offer the chance of price gains when interest rates fall. Rath recommends exchange traded funds (ETFs) for investing in bonds. “This allows you to invest widely in many securities and also select the maturities appropriately.”
Stocks also promise opportunities
Stocks also promise opportunities in an environment of falling interest rates. “This is especially true if we don’t experience a recession, but rather a soft landing,” says Kaim. “Then we would have falling interest rates, which lead to lower refinancing costs, while at the same time stable corporate profits, which would be an ideal environment for stocks.” However, it cannot be assumed that share prices will only rise in an interest rate reduction cycle. “In principle, I expect that falling interest rates will justify higher valuations for stocks, but they are no longer cheap at the moment and we have many uncertainty factors and risks, which is why corrections should not be ruled out,” says Rath.
It is also questionable whether the entire stock market benefits equally. “We are seeing weak economic development, especially in the euro area, which is why I would rather avoid cyclical sectors such as automobiles or chemicals,” says Kaim. To do this, he recommends choosing companies from high-growth industries, especially technology stocks.
Boost for the real estate market
Falling interest rates are also generally good news for the real estate market. “The financing costs are actually falling again,” says Kaim. “While they peaked at over 4.5 percent, customers can currently get ten-year financing for less than three percent.” In addition, real estate prices appear to be stabilizing. “In some cases they are even rising again,” says Rath. “Lower financing costs, high rental income and increased wages mean that households have more money in their pockets and are slowly investing in real estate again.”
Many asset classes appear to be becoming more interesting in an environment of falling interest rates, while overnight or fixed-term deposits are becoming less attractive. Investors should therefore take advantage of the opportunities offered by the interest rate reduction cycle.
