In this month’s update, we look at the key economic developments in Australia and around the world.
Key Points:
- Long dated Government Bond yields surge higher.
- Higher oil prices resulting from Iran war leading to higher inflation globally.
- Federal Reserve reacts to higher oil prices and stronger economic data, increasing interest rates by 0.25%.
- The RBA similarly increased the Official Cash Rate by 0.25%, but our economy is weaker.
We hope you find this month’s Economic Update helpful. If you have any feedback or questions about the report, please contact your Financial Adviser.
The Big Picture
Long bond yields surge
Long bond yields – like those of 10-year and 30-year US Treasury bond yields – surged at the end of September. One can never be certain why markets do what they do. However, related yields around the world surged on about the same day!
The Fed lifts rates
The US Federal Reserve had already raised its ‘Federal funds (cash) rate’ in the middle of the month, to a mixed response.
Two of the men reportedly shortlisted for Federal Reserve Chairman in May this year were David Zervos and Rick Reider. In a CNBC interview before the Fed decision, each said the Fed would raise interest rates (and it did). However, they both said it shouldn’t! Zervos doubled down on his view in an interview at the end of the month.
We shared the view of Zervos and Reider, not that of the new Fed chairman, Kevin Warsh. All the experts on CNBC before and after the announcement said a rate increase would have no major impact on inflation. That’s because the troublesome components – particularly oil and insurance – are not interest-rate sensitive.
The new chairman gave an insight into his thinking in an otherwise bland, abrupt and short media conference. He said the rate increase would remove ‘some accommodation in interest rates’.
What is the neutral rate?
Accommodation is the term for monetary policy that is ‘easing’ (interest rates declining) to help promote economic growth. The converse is tightening. The rate that divides these two policy stances is ‘the neutral rate’.
Warsh has previously stated that the neutral rate is an academic construct with no real value in policy making. He raised the Fed rate from a range of 3.50% to 3.75% to a range of 3.75% to 4.00% (a 25 bps or 0.25% pts increase). In doing so, he implicitly stated that he sees the neutral rate as the new Fed funds rate or higher.
Otherwise, he would have been tightening rather than removing presumably unnecessary accommodation. That is a very important distinction for following the Fed’s thinking over the coming months!
Before the pandemic, there seemed to be some consensus that the neutral rate in the US and Australia was about 2.5% to 3%. No one can accurately measure it, and maybe it changes over time – hence the ‘academic construct’ reference.
A stronger US economy
A week after the Fed decision, the US released its Purchasing Managers Index (PMI) data, which was quite ‘strong’. Long dated government bond (Treasury) yields then surged. This was possibly because markets expect the Fed to respond to that data at future Federal Open Market Committee (FOMC) meetings.
The Atlanta branch of the Federal Reserve publishes an unofficial ‘GDP NOW’ estimate. Rather than waiting for the following quarter’s data, the Atlanta Fed tries to give real time snapshots of growth. It updates these daily when relevant new data comes out.
Its estimate for the September quarter was over 5% until the last day of September, when it fell to 3.7%. In comparison, official growth rates for the March and June quarters were 2.1% and 2.6%, respectively. Year-on-year growth rates have not dipped below 2% for any quarter since 2022. This is an average to above-average set of growth rates.
Perhaps Warsh is really trying to cap parts of economic growth rather than inflation. Higher interest rates would not likely increase inflation, but they might dampen future excess demand.
Even the most recent jobs data from the first Friday in September was a big upward surprise. Maybe it was a statistical blip. Still, the Fed may be trying to get ahead of possible future demand-side inflation, which Warsh has sworn to do.
The privately compiled ADP jobs data at the end of the month also beat expectations. It showed 90,000 new jobs, against an expected 68,000 and 36,000 the month before.
Most analysts also think recent bond yields have risen because of oil price increases due to the war with Iran. That too is a reasonable assertion. Higher yields have significant consequences for households and businesses in the US and elsewhere.
US mortgage rates climb
Most US home-owners use 30-year fixed-term loans to finance their mortgages. They can refinance these at minimal cost if interest rates go down. So, as 30-year interest rates rise, homeowners are less likely to move home, as the new loan would cost more.
However, first time homeowners might still buy at high mortgage interest rates if they expect rates to fall soon. This is especially true if buying would still save them money compared to renting an equivalent property.
The ‘Mortgage News Daily’ 30-year fixed term US mortgage rate was 7.54% at the end of September. It was 6.0% just before the war with Iran broke out at the end of February 2026. A year ago, it was about 6.5%. The current rate is the highest in around three years.
Since February, the Fed has only increased interest rates once – by 25 bps – on September 16th. Yet mortgage rates surged by nearly 1.5% points during that time! This market reaction could have a major impact on the housing sector and households in general.
Before the Fed decision, the CME FedWatch tool had priced the chance of an October interest rate increase as small. This was because of the proximity of the mid-term elections (3 November). Central banks commonly try to avoid appearing politically aligned or motivated.
After the Fed’s September decision, the odds of another increase in October became very high. Then, a lower-than expected inflation number came out on September 30th, and those odds fell (if the updated FedWatch tool is to be believed).
Even so, according to FedWatch, another increase by December is more likely than not. Over this period, the odds of the rate being 25 or 50 bps higher by year end have held steady at around 90%.
Australia’s economy is weaker
The Australian economy is unquestionably weaker than that of the US. The Reserve Bank of Australia (RBA) frequently states that it made three interest rate increases this year to get ahead of inflation caused by the oil price surge. It did so before the Fed increased rates in this cycle.
This statement is at odds with opinions overseas. Since we do not have a strong economy, the RBA is in danger of causing damage to the economy in the not too distant future.
After the February interest rate increase, RBA governor Michele Bullock stated that it would have no noticeable impact on the economy for at least six months. Such are monetary policy lags. General opinion, shared by the RBA, is that an increase takes about 12-18 months to have its full effect on the economy.
These time lags mean the impact of the February increase might only show up in August data (and the data that follows). This data is usually published in the following month.
The August unemployment rate, published in September, jumped to 4.65% from a low of 3.4% in October 2022. According to the Australian Bureau of Statistics (ABS), the July unemployment rate was 4.48%, 2 pts lower than the latest rate.
What unemployment is really telling us
Bullock has frequently said that our current unemployment rate is low by historical standards. That is true, but the world has moved on.
Participation data shows both males and females in the workforce as a percentage of the relevant population. There have been big swings in their recent trends.
Historically, the participation rate for males exceeded that for females by a wide margin. One obvious explanation is changes in ‘homemaking’ arrangements. Since the pandemic, working-from-home and flexible working have become commonplace. In the last four years, female participation has trended up markedly, while male participation has been flat.
We think part of this increase may be due to women, possibly with young children, now being more able to join the workforce. In turn, that might mean previous unemployment rates are less relevant now.
Before the pandemic, 4.0% was the lowest unemployment rate since the ABS started publishing this data in February 1978. After the pandemic, 3.4% became the new low.
This might well mean the current 4.65% is a ‘worse number’ than before. Benchmark full-employment may have shifted by around 0.6% points (the difference between the two lows, 4.0% – 3.4%).
If so, we should at least consider that 4.65% today is more like 5.25% before the pandemic. Applying that logic, the current unemployment rate points to a poorer economic environment than we may appreciate.
Lessons from the GFC
The 4.0% low occurred in February and August 2008, just as the GFC was arriving. The unemployment rate then rose to 5.3% in February 2009 (just six months later). Four months after that, it hit 5.9%.
During this run-up in the unemployment rate, most economists and the government predicted a recession. The unemployment rate eventually peaked at 6.4% in October 2014.
Unfortunately, unemployment rates often have a lot of upward momentum once they start to rise. Most economists argued that exports to China saved Australia from a recession in the GFC. In contrast, most other Western economies experienced serious recessions.
The case for the RBA to pause
We are concerned that the RBA’s changes to monetary policy this year could unduly and negatively impact economic growth into 2027.
We believe there is a strong case for the RBA to stop increasing interest rates. Instead, it should let the four rate rises so far this year take effect. It should also be ready to reduce rates if and when the economy appears to be falling into trouble.
Only days before the latest unemployment reading of 4.65%, Michele Bullock said we might need unemployment rates of 4.5% to 5.0% to cure inflation.
We don’t agree that an unemployment rate in that range (or any other) would cure the supply-side inflation we are experiencing. However, we are almost in the middle of Bullock’s stated range, and more impact from the February increase will follow.
Of course, the next two increases in the first half of the year will compound the problem into 2027. Also, we won’t start to notice the effect of the September increase until the June quarter of 2027.
The 12-18-month lags imply we will still feel the impact of this rate hiking cycle well into 2028. This would be the case even if the RBA starts cutting interest rates long before. This scenario highlights the shortcomings of data dependency.
What it means for investors
So, what does this mixed picture imply for us as investors? Company earnings in the US are strong. LSEG survey data from brokers who analyse individual companies remains strong for at least a 12-month horizon.
Big tech companies and the like dominate the S&P 500 index. The danger with deviating too far from the index weights to chase that narrowness is that the AI trend could change abruptly.
At the same time, new strength in the broader US economy suggests some investors could benefit from exposure to a large part of the broader index.
The ASX 200 also has strong LSEG earnings’ expectations, but less strong than for the S&P 500. Our economic predictions could lower these LSEG expectations in due course, as the impact of past rate increases becomes clearer.
Our housing sector is certainly more problematic now. Auction clearance rates and some house price data show distinct weakness. Some of this weakness would have come from the earlier RBA rate increases and their effect on mortgage interest rates.
Almost certainly, the changes to negative gearing and capital gains tax announced in the budget have also had an impact on this sector.
With long bond yields far more attractive than in recent years, bonds might play a more useful part in a diversified portfolio at this time.
Part of any reasonable investment plan acknowledges that the unexpected will happen from time to time. Therefore, it is essential for professionals to constantly monitor economies and markets.
US mid-term elections and Iran
The US holds its mid-term elections at the start of November. President Trump has just over two years to run. In an unprecedented move, he is trying to ‘bribe’ voters with a $5,000 ‘Trump dividend’ if the Republicans retain control of the House of Representatives and the Senate.
Many think that the House of Representatives might (otherwise) change to a Democratic majority. However, it would take a lot more change to swing the Senate to a Democratic majority.
Given the eclectic style of Trump’s presidential decision making, it is very hard to predict how he would react to ‘losing the House’. As a result, we cannot rule out increased volatility.
In late September, there were reports of some advances in talks with Iran at the United Nations (UN). There were also reports of advances on Iran in talks between China’s President Xi and President Trump at the White House, following the UN General Assembly in New York. However, Trump rejected the latest Iran offer to ceasefire and open the Straits of Hormuz to shipping.
Trump’s banning of some media outlets from the ‘inner circle’, including CNN, backfired on him during this Xi visit. In a televised ceremony, he cut the ribbon to open his new helipad in the White House gardens. However, there was no sound on TV.
Apparently, in solidarity with CNN and the First Amendment, no TV outlet allowed sound to be recorded. So, there was only vision.
Asset Classes
Australian Shares
Australian equities (ASX 200) had a poor month, losing -3.2% in capital gains. IT (-10.6%) was the worst performing of the 11 sectors. Losses were also large in the Materials sector (-7.3%), Utilities (-4.3%) and Consumer Discretionary (-3.9%). Telcos (+2.5%) and Healthcare (+3.4%) were the only sectors posting gains.
International Shares
The S&P 500 (-0.5%) sustained only a modest loss over September. Losses were much greater in Germany’s DAX (-4.0%), China’s Shanghai Composite (-3.6%) and the UK’s FTSE (-2.0%). Japan’s Nikkei posted a gain of +0.7%, while Emerging Markets posted a modest loss of -0.7%.
Bonds and Interest Rates
The US Federal Reserve
At its September FOMC meeting, the Fed made its first interest rate increase since its last change, a rate cut in December 2025. It moved the Fed funds rate up by 25 bps to the range 3.75% to 4.00%.
Experts on CNBC all said the increase would not do anything for oil-related price inflation. Instead, some growing evidence of a stronger US economy more likely justified the increase.
Fed chair Warsh claimed that the increase would reduce “accommodation in monetary policy”. That must mean he thinks the neutral rate is the new interest rate or higher. Analysts and commentators did not generally express that view before the decision.
Warsh was also unusually brusque in his answers to questions. He did not allow the customary follow-up questions and ended the conference early.
Popular expert opinion before the rate rise was that the Fed would not increase again in October because of
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