At last the long-anticipated diverging interest rate outlook between Australia and the US is a reality, and we can begin to see the effects it is already having.
With the US Fed’s decision to shave a quarter of a per cent off their official interest rates – and Australia’s decision to hold rates steady – the Australian dollar has been finding some strength, hitting the highest level in three months with many pundits tipping it will reach the US70c level quite soon.
With the Fed having now cut rates three times in a row and with current chair Jerome Powell heading for the exits next March and sure to be replaced by someone who shares President Trump’s enthusiasm for lower rates, the US rate cuts look like they might keep coming.
The other political factor that must be remembered is that Trump is heading towards the mid-term elections in November 2026 and he will want to get the economy firing as best he can before then.
Already tax cuts will start flowing through in the form of higher tax returns which should stimulate consumer spending and falling rates will add to that stimulus.
Local Inflation Could Persist
Of course, the one handbrake on all of this is that stubbornly high inflation rates could persist or even rise which will dampen the US economy and enthusiasm for rate cuts, although the Fed may be willing to look past high inflation given its dovish mood.
When it announced its recent cut, many observers were surprised by the dovish remarks of Fed chair Jerome Powell, as well as the decision to cut when inflation remained high.
Traders in the US have already priced in two more rate cuts in 2026, although this may be optimistic but at least one more cut looks to be on the cards.
Aussie Rates on Hold
It was a different situation here in Australia with the RBA governor Michele Bullock pouring plenty of cold water on hopes of another rate cut in Australia this cycle and even suggesting that the next move may well be higher, depending on the data.
That has left Australian financial markets expecting that the next rate move by the RBA will be higher after the central bank held the cash rate steady at 3.6%.
What remains uncertain is the timing of such a rate rise, with a long period of sitting with rates steady is always a chance.
The rise in headline inflation to 3.8% in October was accompanied by a 3.3% rise in the core measure which the RBA concentrates on.
Those numbers look high and sticky and are now well and truly outside the RBA’s target inflation band of 2% to 3%.
Dollar Rising, Shares Not So Much
The divergence in the rate outlook between the Fed and the RBA has been positive for the Australian dollar as comparative bond yields move in Australia’s favour.
There remains plenty of uncertainty around all of this as shown by the weakness in the latest Australian job figures which injected a note of caution into the local rate rise scenario but two trends are emerging that all investors will be wise to take into account.
One is that falling US rates will tend to support the Australian dollar over time and the second is that there may be plenty of stimulus pushed growth to come on the US share market.
While a rising US market adds fuel to our own as a by-product, it is worth noting that the US market is setting fresh records while Australian shares still remain well shy of our October highs.
That makes some sense because as the Australian dollar appreciates, it is effectively raising the global value of share holdings even without a corresponding rise in the share price.
