Ignore the noise around the RBA

It is easy to get swept up in the parlour game surrounding RBA expectations. Australian media is swamped with views around the timing of the next rate cut or rate hike. Global media focuses in on US Federal Reserve communication to gauge the propensity for timing and magnitude of rate movements. Consensus views are noisy and market economists adjust their views rapidly and sometimes materially. In our view, the timing of rate cuts is less important than the direction. And the direction matters more relative to what is priced in, both for bonds and equity markets. Right now, we think rate cuts are marginally more likely over the medium-term than rate hikes. Whether we are right or not, we suggest the uncertainty urges caution for investors across asset classes.

Market pricing for RBA rates is noisy.

Chart 1 shows how expectations for RBA cash rates moved through 2025. In early 2025, markets were priced for roughly 0.75% of rate cuts through the year. In early April, after President Trump’s Liberation Day, economists and markets called for emergency rate cuts – pricing in a December 2025 Cash rate of 2.75%. Deep rate cuts remained the market view until Q4 when a high inflation print abruptly resulted in rate hikes priced – one full rate hike is now priced by June 2026.

Chart 1: Market pricing for the RBA is noisy

Source: Bloomberg LP, Ascalon.

The rates outlook hinges on inflation versus growth.

Inflation jumped back above the RBA’s 2%-3% target in 2025. This reflected an improvement in Australia’s economic growth, increases in housing within the inflation print, and some stickiness in services inflation. Australia’s economy improved over 2025, exiting per capita recession suggesting resilient growth. Rate cuts drove a reacceleration in housing CPI that does not bode well for inflation in the near-term.

Chart 2: Inflation is back above the RBA target.

Source: Bloomberg LP, Ascalon.

In contrast, Australia’s labour market continued to soften. Unemployment trended higher and the material weakness in job ads suggests unemployment could reach 5% through 2026.

Chart 3: Job ad weakness suggests unemployment could continue higher.

Source: Bloomberg LP, Ascalon.

The RBA will need to carefully weight these tensions as it sets monetary policy in the near-term. We are sceptical that the Bank will move to hike rates any time soon. But we do not expect near-term rate cuts either. Either way, this near-term uncertainty could drive volatility across equity and Australian government bond markets that suggests caution for investors.

What matters for investors?

Longer-dated Australian government bonds surged after markets moved to price in around 2 rate hikes over 2026. The move higher suggests that term premia increased across the Australian government bond yield curve. Some of that premium will include an increase in inflation expectations.

Chart 4: Australian government bond yields surged in Q4 2025.

Source: Bloomberg LP, Ascalon.

After the move higher, we suspect there is more scope for Australian government bond yields to move lower, rather than higher. Either rates will be hiked and term premium will reduce as the pathway becomes clearer, or rates will be cut and the term structure will move lower.

For investors, that suggests government bonds, with yields now closer to 5% than 4%, offer both a decent return from yield, and the benefit of some downside protection if the economy does slow.

The risk is that if yields grind higher, there will be a drag from capital losses. But even that impact will be relatively minor because of the higher starting yield.

For equity investors, there is some upside risk if markets have the rate pathway wrong. A move to reprice in rate cuts could support equity valuations at their current high levels.