Cash becoming trash again as RBA brings out the punch bowl

Once again, the mantra that cash is trash is starting to be proved in real life.

Reserve Bank governor Michele Bullock, in announcing the second official interest rate cut of 25 basis points to 3.85%, made it clear that the RBA now believes it has a handle on inflation and is free to apply more official cuts this year.

That dovish commentary, along with the admission that the RBA had considered a 50-basis point cut, sent bond yields lower and caused a reduction in predicted official rates by the end of the year.

Two or three more cuts to come this year

That resulted in money markets indicating that the cash rate will be as low as 3.17% by the end of the year, implying up to three straight cuts before Christmas.

Cash had a fairly brief moment in the sun after the ultra-low official cash rate of just 0.1% that operated during the pandemic was finally overtaken by a run of 13 interest rate rises – four of them 50 basis point rises – which saw cash rates peak at 4.35% from November 2023.

While that rate was tough medicine for heavily indebted households, it was a welcome relief for retirees and other savers who could finally get some income from their cash holdings – although not enough to overcome inflation in most cases.

There are a lot of savers in Australia who hold more than $1 trillion in cash and term deposits but that number may fall as returns begin to shrink again.

The RBA held firm on that 4.35% cash rate until February this year when it was reduced to 4.1%, followed by the latest cut to 3.85% which now looks like being followed by further cuts this year.

With the rash of inflationary price rises in the aftermath of the pandemic being battled by rising interest rates, Michele Bullock’s commentary now indicates that the RBA thinks inflation is under control and rates can start falling as one way of dealing with the trade problems caused by Donald Trump’s tariffs.

What to do with cash now?

For investors that leaves the issue of how much cash to carry and where to invest it for the best return as a very live question.

Traditionally, term deposits with the banks have been one way to lock in high interest rates, however to some extent the banks have pre-empted this by pre-emptively cutting the rates on offer.

Indeed, Mozo comparison numbers showed that April was the peak month for cuts to term deposit rates, with more than 650 term deposit rate cuts this year, and that was mostly before the official rate cut.

This shows that investors need to take a broad view and compare what deposit rates are being offered and not just stick to their own bank out of habit.

Many banks also offer high interest deposits with a raft of conditions which can be useful if you can comply with them but can also be a drag compared to a more straightforward deposit.

Time for bonds and other alternatives?

Another strategy is to buy bonds, which tend to rise in price even as yields fall because they represent past higher rates that were on offer.

Other possibilities include moving a portion of cash holdings into sectors that may be buoyed by lower interest rates including property, private credit, corporate bonds, subordinated debt, infrastructure and the share market in general.

There are a wide range of sovereign and corporate bond ETFs of varying levels of safety and returns which can give you diversified exposure to most of these sectors, although bear in mind that virtually all of these cash alternatives will come with a greater risk of capital loss.

One thing that is clear though, interest rates are on the way down and the days of earning a risk-free return of 5% plus are largely behind us.

We have enjoyed a brief window of more reasonable cash returns, albeit below inflation, but that window is now quickly closing.