Introduction to Australian Markets
For much of 2025, Australian markets had been expecting a gentle decrease in the Reserve Bank of Australia’s (RBA) official cash rate (OCR). This decrease was anticipated as inflation was easing back into the RBA’s target band of 2-3%. However, recent stronger-than-expected economic data has changed these assumptions.
Understanding the Cash-Rate Futures Implied Yield Curve
The cash-rate futures implied yield curve is a tool that shows where investors think the official cash rate will be in the future. By looking at this curve, we can see how expectations for interest rates have changed over time. At the start of 2025, the curve showed that the market expected the OCR to be around 3.68% by September. After the RBA’s last interest rate cut in August, the OCR is now at 3.60%. This means that the market was fairly accurate in its prediction of where the OCR would be nine months later.
Changes in the Implied Yield Curve
However, the curve also showed that the market expected the OCR to bottom out at 3.50%. This is known as the "terminal rate". Given that the terminal rate was 3.50% at the start of the year, the market was pricing in a 40% chance of a further interest rate cut to 3.35%. This is because the RBA typically moves interest rates in 25 basis point increments.
Factors Affecting the Market’s Expectations
Since January, the rate of inflation in Australia has fallen faster than expected. This allowed the RBA to cut interest rates more aggressively than the market was anticipating. As a result, the market’s expectations for the OCR have shifted. The current forecast is for two more 25 basis point cuts to 3.10% by July next year. However, the implied yield curve has risen recently, which means that the market is now pricing in a lower chance of these cuts.
Recent Changes in the Market’s Forecast
The current implied yield curve is higher than it was a week ago and significantly higher than it was three weeks ago, immediately after the RBA’s August Board meeting. This means that the market has pared back 13 basis points of cuts to the OCR, which is just over half a typical rate cut. This change in the market’s forecast is significant and could potentially wipe out any further cuts to the OCR.
Kiss Your Rate Cuts Goodbye?
If the terminal rate were to rise 50 basis points over the next eight months, it would completely wipe out any further cuts to the OCR. This would be a significant change and could have major implications for investors and mortgage holders. The recent increase in the market’s forecast terminal rate is a sign that the market is becoming more cautious about the outlook for interest rates.
Conclusion
In conclusion, the Australian market’s expectations for the OCR have changed significantly over the past year. The recent stronger-than-expected economic data has caused the market to reassess its expectations for interest rates. While the current forecast is still for two more 25 basis point cuts to 3.10% by July next year, the recent rise in the implied yield curve suggests that these cuts are no longer a certainty. As the market continues to evolve, it will be important to keep a close eye on the implied yield curve and other economic indicators to get a sense of where interest rates are headed.
