Insights

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On 7 July the AFR published a list of 37 Economists who had answered a poll on when the RBA would next cut rates. 32 of them thought that the RBA would cut on 8 July. Only 5 of them did not believe the RBA would cut on 8 July. I was one of them. The RBA did not cut.

So today I will talk about how I came to that decision. First, lets look at our model of official interest rates. Back in January 2015 I went to a presentation in San Franciso by Stan Fishcer . Stan was a celebrated economist who at that time was Ben Bernanke's deputy at the Federal Reserve. Stan gave a talk about how the Fed thought about interest rates.

Stan presented a model of R*. This is the real short rate of the Fed Funds Rate at which monetary policy is at equilibrium. Unemployment was shown as a most important variable. So was inflationary expectations.

This then logically lead to a model where the nominal level of the Fed funds rate was driven by Inflation, Inflationary expectations and unemployment. Unemployment was important because of its effect on future inflation. The lower the level of unemployment the higher the level of future inflation and the higher the level of the Fed funds rate. I tried the model and it worked. It worked not just for the Fed funds rate. It also worked in Australia for Australian cash rate.

Recently though I have found that while the model has continued to work to work for the Fed funds rate It has been not quite as good in modelling that Australian Cash Rate. I found the answer to this in a model of Australian inflation published by the RBA. The model showed Australian Inflation was not just caused by low unemployment, It was also caused by high import price rises. Import price inflation was more important in Australia because imports were a higher level of Australian GDP than was the case in the US.

This was important in Australia than in the US because Australian import price inflation was close to zero for the 2 years up to the end of 2024. Import prices rose sharply in the first quarter of 2025. What would happen in the second quarter of 2025 and how would it effect inflation I could not tell. The only thing I could do is wait for the Q2 inflation numbers to come out for Australia.

I thought that for this reason and other reasons the RBA would also wait for the Q2 inflation numbers to come out. There were other reasons as well. The Quarterly CPI was a more reliable measure of the CPI and was a better measure of services inflation than the monthly CPI. The result was that RBA did not move and voiced a preference for quarterly measure of inflation over monthly version.

Lets look again at R* or the real level of the Cash rate for Australia .When we look at the average real Cash rate since January 2000 we find an average number of 0.85%. At an inflation target of 2.5 % this suggests this suggest an equilibrium Cash rate of 3.35%

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What will happen next? We think that the after the RBA meeting of 11 and 12 August the RBA will cut the Cash rate to 3.6%

We think that after the RBA meeting of 8 and 9 December the RBA will cut the Cash rate to 3.35%

Unless Quarterly inflation falls below 2.5% , the Cash rate will remain at 3.35% .

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Investment Watch is a quarterly publication produced by Morgans that delves into key insights for equity and economic strategy.

This publication covers

Economics - 'The challenge of Australian productivity' and 'Iran, from the Suez blockade to the 12 day war'
Asset Allocation - 'Prioritise portfolio resilience amidst the prevailing uncertainty'
Equity Strategy - 'Rethinking sector preferences and portfolio balance'
Fixed Interest - 'Market volatility analysis: Low beta investment opportunities'
Banks - 'Outperformance driving the broader market index'
Industrials - 'New opportunities will arise'
Resources and Energy - 'Getting paid to wait in the majors'
Technology - 'Buy the dips'
Consumer discretionary - 'Support remains in place'
Telco - 'A cautious eye on competitive intensity'
Travel - 'Demand trends still solid'
Property - 'An improving Cycle'

Recent months have been marked by sharp swings in market sentiment, driven by shifting global trade dynamics, geopolitical tensions, and policy uncertainty. The rapid pace of US policy announcements, coupled with reversals, has made it difficult for investors to form strong convictions or accurately assess the impact on growth and earnings. While trade tariffs are still a concern, recent progress in US bilateral negotiations and signs of greater policy stability have reduced immediate headline risks.

We expect that more stable policies, potential tax cuts, and continued innovation - particularly in AI - will support a gradual pickup in investment activity. In this environment, we recommend prioritising portfolio resilience. This means maintaining diversification, focusing on quality, and being prepared to adjust exposures as new risks or opportunities emerge. This quarter, we update our outlook for interest rates and also explore the implications of the conflict in the Middle East on portfolios. As usual, we provide an outlook for the key sectors of the Australian market and where we see the best tactical opportunities.

Morgans clients receive exclusive insights such as access to our latest Investment Watch publication. Contact us today to begin your journey with Morgans.

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At the beginning of the week, I was asked to write something about Iran. When I started looking at what had been happening , I realised that what we were talking about begins with an action by a proxy of Iran back in November 2023. How  that was initially handled with the Biden regime, and how then it was dealt with  deftly by Trump this year,   in turn led to  the need for an attack on Iran's nuclear facility.

Winston Churchill noted in his first volume of his history of the Second World War that it was important to understand that the United States is primarily a naval power. Indeed, the US remains the world dominant naval power. As such, two major strategic concerns remain for the US : the control of the Suez Canal and the Panama Canal .

To the US The idea that another country might block access to either of these must be intolerable. Yet what began happening, beginning on the 19th November 2023, was that , Houthi rebels that controlled a the northern part of a small country in southwestern Arabia, began to act. These Houthi rebels were acting as a proxy for Iran. They were funded by Iran, and armed with Ship-killing rockets, by Iran.

By February 2024, they had attacked 40 ships which had been attempting to sail northwards towards the Suez Canal. By March 2024, 200 ships had been diverted away from the Suez Canal and forced to make the longer and more expensive voyage around the Cape of Good Hope of South Africa. At this point, I think The Economist magazine said that this was the most severe Suez crisis since the 1950s.

The U.S. did respond. On the 18th December 2023, the U.S. had announced an international maritime force to break the Houthi blockade. On the 10th January, the UN National Security Council adopted a resolution demanding a cessation of Houthi attacks on merchant vessels.

As of the 2nd January 2024, the Houthis had already recorded 931 American and British airstrikes against sites in Yemen. Then Trump came to power. To Trump, the idea of the proxy of Iran blockading the Suez Canal could not be tolerated.

From the 15th March 2025, Trump began "Operatation  Rough Rider". This was named for the cavalry commanded by the then-future President Theodore Roosevelt, who charged up San Juan Hill in Cuba during the Spanish-American War of 1898. The U.S. then hit the Houthis with over a thousand airstrikes. So they were bombing at ten times the rate they previously had been. The result of that was that by the 6th March 2025, Trump announced that the Houthis, these proxies of Iran, had capitulated as part of a ceasefire brokered by Oman. This directly led to the main game.

It was obvious that the decision to do the unthinkable, and block the Suez Canal, had come from Iran.
What other unthinkable things was Iran considering?

It is obvious that Trump now believed that the next unthinkable thing that Iran was considering was nuclear weapons. As Iran's other proxies collapsed, Iran's air defence collapsed. In turn, this gave Trump the room to act, and he took it. He launched a bombing raid which severely disabled Iran's nuclear capacity. Some say it completely destroyed it.

Iran retaliated by launching 14 rockets at the American base in Qatar, warning the Americans this was going to happen, and this had no other effect than allowing Iran to announce a glorious victory by themselves over the Americans. Iran had thought the unthinkable and had achieved what was, to them, as a result, an unthinkable reverse.

The ceasefire that has followed has been interpreted by markets as a relief from major risk. Now, the major effect of this on markets has been a dramatic rocketing in the oil price, followed by a fall in the oil price. So I thought I’d look at the fundamentals of the oil price, from running two of my models of the Brent price, using current fundamentals.

Now, the simplest model that I’ve got explains 63% of monthly variation of the Brent oil price. And it’s based on two things. One is the level of stocks in the U.S., which are published every week by the Energy Information Administration .  Those stocks are  down a bit in the most recent months because this is the summer driving season where oil stocks are being drawn down to provide higher demand for gasoline. So that’s a positive thing. And the other thing that I’ve been talking about this year is that I think  we’re going to see a steady fall in the U.S. dollar, and that’s going to generate the beginning of a recovery in commodities prices. So if I also put the U.S. dollar index into this model, it gives me an equilibrium model now of $78.96. And that’s about $US12  higher than the oil price was this morning.

If I strengthen that model by adding the U.S. CPI, because, you know, the cost of production cost of oil raises over time, that increases the power of the model . And that lifts the equilibrium price very considerably to $97 a barrel, which is $30 a barrel higher than it currently is. So I regard that as my medium-term model, and the first one is my short-term model.

What’s really interesting is that the U.S. dollar  has continued to fall.  That puts further upward pressure  on the oil price. So in spite of this crisis having been solved, I think we’re going to see more upward price action on the oil price by the end of the year.

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We think the US economy is currently experiencing solid growth, with data from the Chicago Fed  National Activity Index indicating an annual growth rate of just above  2%. This aligns with projections from other parts of the Federal Reserve System, such as the New York Fed. The New York Fed’s weekly Nowcast, updated every Friday, estimates that for the second quarter of 2025, the US economy is growing at an annualised rate of 2.34%, surpassing the 2% mark. This robust growth is consistent with our model’s view that the US economy is now performing strongly. However, we anticipate a slowdown in the second half of 2025.

On 18 June the Fed released its Summary of Economic Projections  with the Federal Reserve’s  forecasting US GDP growth to drop to 1.4% in 2025, down from their March estimate of 1.7%. Looking further ahead, growth is expected to pick up slightly to 1.6% in 2026 and 1.8% in 2027, aligning with the long-term trend growth rate of around 1.8%. We believe this recovery trend could be even  higher,  driven by reduced regulation under the second Trump administration and aggressive tax write-offs for companies building factories in the US, allowing 100% write-offs for equipment and buildings in the first year. This policy should foster stronger systemic growth.

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The Fed expects that as the economy slows,  unemployment is projected to rise to 4.5% from the current level of 4.2%. Inflation, measured by the Consumer Price Index (CPI), is running at 3.5% this year, approximately 50 basis points higher than the Personal Consumption Expenditures (PCE) index of 3.0%, with 1.6% of this  inflation  attributed to tariffs. The Fed expects PCE Inflation  to ease to 2.4% in 2026 and 2.1% in 2027. The Federal Reserve anticipates cutting the effective  federal funds rate, currently at 433 basis points (according to the New York Fed), by 50 basis points by the end of 2025, followed by an additional 25 basis points in each of the next two years. This aligns with our own Fed Funds rate  model’s current equilibrium federal funds rate of  3.85% . The Fed Outlook  supports our scenario of a slowing US economy and rate cuts in the second half of 2025 and beyond. A falling US dollar is then expected to exert upward pressure on commodity prices, benefiting Australian Equity markets.

Taking questions during the Press Conference after releasing the Fed statement  ,Federal Reserve Chair Jay Powell,   addressed the certainty and uncertainty surrounding the inflationary effects of tariffs. Initially, at the start of 2025, the inflationary impact of tariff policies was unclear, but three months of favourable inflation data have provided this clarity, indicating that the inflationary effects are less severe than anticipated. Powell noted that the Feds own uncertainty on the inflationary effects of  tariffs  peaked in April 2025, and the Federal Reserve now has a clearer understanding that  the inflation effects, are lower than initially expected.

The Fed view  supports our own scenario of a slowing US economy in the second half of 2025, allowing for Fed rate cuts  . This in turn should then lead to  a falling US dollar, which we in turn  expect to drive rising commodity prices.

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The second half of 2025 will be an interesting time for everyone. Geopolitical uncertainty prevails. How will all of this impact the Australian investor and in particular, their wealth and retirement savings? Whether you are an accumulator, saving for short- and long-term goals, or a retiree, hoping for a comfortable retirement, the ability to manage this uncertainty will be key.

When we published the previous Your Wealth – First Half 2025, the Division 296 Bill (Div296) was also facing uncertainty. The Bill was eventually blocked in the Senate prior to the Federal Election. The Labor Party succeeded in winning so it’s Ground Hog Day for Div296. The Government doesn’t have the numbers in the Senate to pass the Bill without support from other parties. The Greens are the likely negotiating party but will undoubtably have their own agenda. Regardless, there is a high probability this legislation will be passed once Parliament resumes.

Our message to our clients is to wait until we know more details and to not act in haste.

In addition to our Feature Article which provides further insights on Div296, this edition also Spotlights the Aged Care changes due this year, with the start date pushed back to 1 November.

We hope readers enjoy this edition of Your Wealth.

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Morgans clients receive exclusive insights such as access to our latest Your Wealth publication. Contact us today to begin your journey with Morgans.

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This morning, I was asked to discuss Sarah Hunter’s presentation from yesterday. Sarah, the Assistant Governor and Chief Economist at the Reserve Bank of Australia (RBA), delivered a detailed and competent discussion on the conventional view of tariffs’ impact on the international economy. She highlighted that tariffs typically increase inflation and reduce economic output, a perspective echoed by the OECD in a similar presentation overnight. Sarah’s analysis focused on the potential shocks tariffs could cause, particularly their effects on GDP and inflation.

Drawing on my experience as an Australian trade commissioner and my work in Australian embassies, I found her presentation particularly interesting. My background allowed me to bring specialist knowledge to the conversation, which I believe gave me an edge. Notably, I observed that the RBA seems to lack analysts closely tracking individual policymakers in the Trump administration, such as Scott Bessent, whose views on tariffs and competition differ from the general assumptions. The conventional view assumes a world of perfectly competitive countries adhering to international trade rules and unlikely to engage in conflict—a scenario that doesn’t align with the current global trade environment, especially between China and the United States.

China, operating as a Marxist-Leninist economy, aims to dominate global markets by building monopolies in areas like rare earths, nickel, copper, and other base metals. It maintains a managed exchange rate, despite promises to the International Monetary Fund for a freely floating currency. If China allowed its currency, the RMB, to float, it would likely appreciate significantly, increasing imports and reducing its trade surplus. This would create a more balanced international trade environment, potentially reducing the need for other countries to impose tariffs. However, major institutions like the OECD and RBA seem to misjudge the nature of this trade shock, relying on outdated assumptions about global trade dynamics.

The international community also appears to overlook specific U.S. policy intentions, such as those articulated by figures like Peter Navarro and Scott Bessent. The U.S. aims to use tariffs selectively to bolster industries like pharmaceuticals, precision manufacturing, and motor vehicles. This misunderstanding leads public institutions to perceive unspecified risks, as reflected in Sarah’s otherwise able presentation. Because the RBA and similar institutions view the world as fraught with undefined risks, they are inclined to keep interest rates low, responding to perceived threats rather than an equilibrium model.

Interestingly, data from the U.S. economy contradicts the expected negative impacts of tariffs. The Chicago Fed National Activity Indicator, a reliable gauge of economic growth since the 2008 financial crisis, shows U.S. growth above the long-term trend for the first four months of this year. This suggests resilience despite tariff-related shocks. Ideally, growth will slow later this year, prompting the Federal Reserve to cut rates, facilitating a soft landing and a decline in the U.S. dollar to boost global commodity prices. However, this nuanced outlook wasn’t evident in yesterday’s presentation.

Moreover, the anticipated rise in U.S. inflation due to tariffs isn’t materialising. Scott Bessent recently noted that U.S. CPI inflation is lower than expected, with core inflation shown as the (16% trimmed mean) at 3% for the past two months . Core inflation  excluding  food and energy CPI  is only at 2.8%. This suggests that Chinese suppliers are absorbing tariff costs to maintain market share, rather than passing them on as higher prices. Recent Chinese data supports this, showing a slight decline in manufacturing confidence and coal consumption, indicating reduced factory output and electricity use. This points to a modest slowdown in China’s economy. So far the expected negative effects on U.S. prices and output are not occurring.

In summary, the fears expressed by institutions like the RBA and OECD about the Trump administration’s trade policies appear overstated. The U.S. economy is not experiencing the predicted declines in output or increases in inflation. While these effects may emerge later, the current data suggests that the risks are not as severe as anticipated, highlighting a disconnect between theoretical models and real-world outcomes.

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