US Federal Reserve’s Impending Interest Rate Cut: 3 Sectors That Will Be Impacted
The US Federal Reserve made its first interest rate cut in four years back in September when it lowered its benchmark federal funds rate by 0.5 percentage points.
With inflation heading lower and the labour market showing signs of strain, the move was a decisive one aimed at boosting spending and spurring corporate investments.
The US central bank plans to move ahead with further interest rate cuts in the coming months, with the first set to happen in early November.
You may be wondering which sectors are sensitive to these interest rate movements.
Here are three that should be impacted by these impending interest rate declines.
Banks
Banks run a business that is very sensitive to global interest rates.
Essentially, their main business is to accept deposits from savers and then lend that money out to individuals and businesses seeking loans.
Banks make money by lending out money at higher rates than those that they pay out on their deposits, in what is termed the “net interest income”, or NII.
If interest rates head higher, banks have more leeway to increase their loan rates while holding deposit rates steady, thus increasing its net interest margin (NIM), computed as the difference between its loan and deposit rates.
Higher NIMs will translate into better NII for the bank and help it to boost its overall income.
DBS Group (SGX: D05) illustrated this with its recent third quarter of 2024 (3Q 2024) results.
Total income jumped 11% year on year to a record high of S$5.7 billion on the back of a 3% year-on-year increase in NII to S$3.8 billion.
Net profit came in at S$3 billion, up 17% year on year and also at a record.
Should interest rates decline sharply over the next 12 to 18 months, it will have a negative impact on banks’ total income and earnings.
However, banks have another avenue to buffer this decline – their non-interest income.
Non-interest income comprises fees from asset management, card spending, and loans.
For 3Q 2024, DBS saw its non-interest income surge 32% year on year to S$1.1 billion.
REITs
Another sector that relies heavily on interest rates is the REIT sector.
REITs comprise of portfolios of real estate assets that are bundled together and traded as a security on stock exchanges.
They are mandated to pay out at least 90% of their earnings as distributions to enjoy tax benefits.
REITs take on loans to fund their operating and capital expenditure and these loans are not paid off but rolled over, with just the interest expenses being serviced over time.
Hence, higher interest rates are bad for REITs as they result in higher interest expenses.
In turn, these higher costs will crimp their distributable income and lead to lower payouts.
Case in point: Frasers Logistics & Commercial Trust (SGX: BUOU) recently released its fiscal 2024 earnings ending 30 September 2024.
Although revenue rose 6.2% year on year to S$446.7 million, the REIT’s finance expenses ballooned, surging 40.4% year on year to S$65.7 million.
Because of this, its distribution per unit (DPU) dipped by 3.4% year on year to S$0.068.
Higher interest rates also make it tougher for REITs to conduct acquisitions as their hurdle rate for acquisitions goes higher.
Many REITs have increased the fixed-rate portion of their borrowings to mitigate this headwind.
But with interest rates poised to go lower, it could be a boon for REITs and spell relief for income-seeking investors.
Technology companies
The third sector that will be affected by interest rates is none other than the popular technology sector.
This sector includes trillion-dollar companies such as Apple (NASDAQ: AAPL), Nvidia (NASDAQ: NVDA), and Meta Platforms (NASDAQ: META).
Apple and Meta Platforms have gone big on the generative artificial intelligence (AI) space with significant investments in this nascent technology.
Apple introduced Apple Intelligence recently when it launched its new iPhone 16, and the inclusion of this technology should help to boost sales of its new devices.
Meta also plans to invest billions of dollars into generative AI which will power its social media apps such as Facebook and Instagram.
As for Nvidia, the graphics processing unit (GPU) company is coming up with its new Blackwell chip in 2025.
Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOGL) are also reportedly sinking billions of dollars into AI to gain an advantage.
This level of spending implies that the technology companies will have to pile on debt so that they have the funds to spend on research and development.
Declining interest rates will benefit these companies as they have to fork out less in finance expenses when they take up additional borrowings.
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Disclosure: Royston Yang owns shares of DBS Group and Frasers Logistics & Commercial Trust.
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