HLS, PGC, VRT:Are these Medical technology stocks undervalued?

Summary

• Negative rates occur when borrowers get paid to borrow money while savers are penalised for saving money.
• RBA views negative rates as an extraordinarily unlikely course of action in Australia and stated that they could put downward pressure on the Australian dollar.
• Infrastructure companies and airlines are likely to benefit from negative rates policy as they are high debt businesses, and debt gets cheaper when rates go negative.
• Westpac chief, Bill Evans has stated that negative rates can have a much stronger effect on lowering the Australian dollar than any currency intervention.
• CBA Economist Gareth Aird has stated that interest rates are likely to be negative for several years.

Interest rates are considered as the main lever to adjust monetary policy and maintain balance in the economy. Negative interest rates are an unconventional monetary policy tool and are defined as the price paid to borrow money. If a central bank implements negative rates, it implies interest rates have fallen below 0%.

Negative rates can boost the economy by encouraging consumers and banks to take up more risk by borrowing and lending money. It is a bizarre situation where borrowers are paid to borrow while savers are penalised for saving.

ALSO READ: Can Negative Interest Rates help Economies?

ECB (European Central Bank) was the first bank to adopt negative interest rates in 2014 to address the Eurozone crisis. ECB had lowered its deposit rate to -0.1% that year in an endeavour to delay deflation in the economy. The same policy was adopted in Japan, which moved to 0 interest policy in 1999, and its key rate has been negative since 2016.

The Australian dollar on the watch list

RBA reduced its cash rate to a record low of 0.25% in mid-March, ending its long-term rate cutting cycle. RBA Governor, Philip Lowe in a parliamentary commentary stated that negative rates are still extraordinarily unlikely in Australia even though the unemployment rate may rise to 10% by the end of 2020.

RBA in its August monetary policy meeting concluded that since AUD was in line with its fundamentals, and the market was working well; there was not a case for intervention in the foreign exchange market as that would have constrained effectiveness.

The Board stated that though negative rates have the benefit of downward pressure on the exchange rate, they come with costs as they can force people to save more rather than spend and stress the financial system which can hurt credit supply. RBA stated that it would not increase the cash rate until progress is made towards full employment, and it is confident that inflation will be between 2-3% target band.

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However, Bill Evans, Westpac Chief Economist, has stated the benefits of negative rates to the economy for it to stay competitive in the coming months. The Bank has stated that AUD has entered into a long upswing period to continue until the end of the next year. The country can benefit from a lower exchange rate as Australia is a small open economy with large foreign liabilities.

Mr Evans has raised his forecasts for 2020 and 2021 in terms of AUD to USD 0.75 from USD 0.72 and predicting AUD to reach USD 0.80 by the end of 2021, US 5 cents lift from the earlier forecast of US 4 cents rise. The lift came amid high iron ore prices and firm commitments by central banks to aid liquidity and demand, the possibility of a vaccine and ongoing government stimulus.

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He added that the negative interest rates are likely to have a stronger effect on lowering the AUD than currency intervention. A rising AUD would pose a challenge for RBA because it would raise the cost of exports that would weigh on the growth of the economy.

Westpac also projected GDP to elevate by 2.8% in the December quarter backed by the reopening of the Victorian economy and ongoing progress in the other states. The Bank also predicted 3% growth of Australian economy in 2021, which is lower than RBA’s prediction of 5% growth in the same year. Hence, more accommodative policy settings might be needed as a rising AUD is blurring the growth rate for the economy.

Negative rates can prove to be a headwind for ASX shares

Negative rates can limit an array of assets that buyers may utilise to produce actual returns to largely only shares and property. Negative interest rates do not bode well for banks who will have to try making a profit by convincing clients to hold their cash with them for no reward or even under financial penalty.

Simultaneously, negative rates can drive corporate and institutional capital into higher returning investments that improve economic development or offshore operations that can further put descending pressure on the exchange rate.

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Further, negative rates can positively affect infrastructure companies and airlines as they have high debt requirements, and high debt businesses will be benefitted as the cost of debt gets cheaper.

Commonwealth Bank economist Gareth Aird stated that interest rates were likely to remain low for “many, many years”. He stated that RBA cannot stimulate the credit demand by further lowering interest rates as it has done in the past.

Hence, negative rates are a monetary policy tool used during unprecedented times and require corresponding directives to make them work.