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Central Bank Policy Rate Changes in 2024*

Thankfully as active bond managers, we have not been confined to the pavilion waiting for the runs to come. We often talk with clients and consultants about the vast global platform that we operate on at �۶���Ƶ Asset Management and the unique perspectives that this enables us to bring to the Australian market. We cannot recall a time like 2024 when it paid so well to have this global approach to our Australian fixed income funds. It has been the appreciation of the breadth and depth of the global easing cycle that has helped us to deliver strong investment outcomes for our clients across both credit and interest rate strategies, even as the RBA failed to trouble the scorers.

First, expectations of global easing calmed fears of a recession benefitting our overweight in credit as spreads contracted to their tightest levels since 1997. Second, we exploited a raft of opportunities in anticipating central bank action around the world allowing us to deliver strong alpha across a number of global rates strategies. This is the investing equivalent of the all too elusive “away win” in cricket.

A global approach has even been helpful in navigating the volatility in domestic rates. Our own analysis as well as our regular dialogue with portfolio managers across �۶���Ƶ’s global network kept bringing us to the same conclusion – there is nothing particularly unique about the position that Australia finds itself in. From an economic perspective, we seem to have much more in common with “the cutters” such as those in Europe, North America and New Zealand than the likes of Russia, Turkey and Japan who went against the grain and raised rates.

This meant that while others predicted confidently that the RBA would need to hike again or pushed their rate cut forecasts further into the never ever, we have been trading our positions with a long duration bias, seeking to benefit from a drop in bond yields as the RBA’s cycle turns towards easing.

Global policy rates (%): The journey from peak to trough

To see this, look to the US at one end of the global interest rate spectrum. Economic exceptionalism dominates with productivity and investment trends the envy of the developed world while the economy’s resilience to higher interest rates has led many to speculate that the “neutral” interest rate is higher than the 2.5% level widely assumed prior to the pandemic. Last year’s “red wave” has turbocharged this narrative and now the Federal Reserve is expected to stop cutting rates close to 4%, which would represent the highest terminal rate in the G10 (Chart 2). This exceptionalism has weighed on US Treasuries with 10-year yields entering the new year close to their cycle highs of 5%.

European markets are at the other extreme with economic performance seeming to revert towards the lacklustre pre-COVID mean. Yet this is well understood and the bond market has already moved to price in a policy rate with a 1-handle on for the European Central Bank and even a possible return to negative rates for the Swiss National Bank.

Labour productivity: GDP per hour worked

Yet the evidence that interest rates should be structurally higher is much more limited in Australia than in the US. First, there are no signs of a capex or productivity boom to raise potential growth (Chart 3). Economists’ warnings that this could prolong inflationary pressure misses the bigger picture: we are on the same low productivity trajectory as prior to the pandemic. Absent any meaningful reform, the economic growth model will continue to be skewed towards growing the labour force (e.g. through migration or childcare policy). This sounds like a reversion to the pre-COVID mean where wages growth disappoint expectations and any lingering inflationary pressures will dissipate.

Second, the market (and the RBA’s models) likely underestimate just how restrictive monetary policy settings are. A deeper dive into the data shows that it is only record government spending and unusually high employment in non-cyclical sectors such as health and social care that has kept the economy out of recession (Chart 4). This is starting to be better appreciated in the public debate, yet what is less widely discussed is what happens when the public sector tailwind fades. After all government spending must keep increasing at the same pace to be additive to growth, which would seem unlikely if the global trend against incumbent governments extends to this year’s federal election. The need to cut rates should become even more obvious in this case in order to provide rapid relief to the interest rate sensitive private sector.

Australia: Private sector GDP growth (% y/y)

Third, the change in the White House should reinforce the trend towards Australian bond outperformance at the margin. The lesson from President Trump’s first term was that hawkish trade policy undermined business confidence in most trade sensitive economies, including Australia. What’s more, Australia imports a very similar basket of goods from China as the US does. This means aggressive tariffs on China from the US could see more imported deflation as discounted Chinese imports are diverted to Australia instead.

AU Bonds: 1yr total return from parallel yield shift (%)