Insights
Investment Watch is a quarterly publication for insights in equity and economic strategy. Recent months have been marked by sharp swings in market sentiment, driven by shifting global trade dynamics, geopolitical tensions, and policy uncertainty.
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.
In our previous discussion on the Fed, we suggested that the deterioration in the US labour market would move the Fed toward an easing path. We have now seen the Fed cut rates by 25 basis points at the September meeting. As a result, the effective Fed funds rate has fallen from 4.35% to 4.10%.
Our model of the Fed funds rate suggests that the effective rate should move toward 3.35%. At this level, the model indicates that monetary policy would be neutral.
The Summary of Economic Projections from Federal Reserve members and Fed Presidents also suggests that the Fed funds rate will fall to a similar level of 3.4% in 2026.
We believe this will happen by the end of the first quarter of 2026. In fact, the Summary of Economic Projections expects an effective rate of 3.6% by the end of 2025.
The challenge remains the gradually weakening US labour market, with unemployment expected to rise from 4.3% now to 4.5% by the end of 2025. This is then projected to fall very slowly to 4.4% by the end of 2026 and 4.3% by the end of 2027.
These expectations would suggest one of the least eventful economic cycles in recent history. We should be so lucky!
In the short term, it is likely that the Fed will cut the effective funds rate to 3.4% by March 2026.
This move to a neutral stance will have a significant effect on the world trade cycle and on commodities. The US dollar remains the principal currency for financing trade in the Indo-Pacific. Lower US short-term rates will likely generate a recovery in the trade of manufacturing exports in the Indo-Pacific region, which in turn will increase demand for commodities.
The Fed’s move to a neutral monetary policy will generate benefits well beyond the US.
Just as an introduction to what I'm going to talk about in terms of Australian interest rates today, we'll talk a little bit about the trimmed mean, which is what the RBA targets. The trimmed mean was invented by the Dallas Fed and the Cleveland Fed. What it does is knock out the 8% of crazy high numbers and the 8% of crazy low numbers.
That's the trimming at both ends. So the number you get as a result of the trimmed mean is pretty much the right way of doing it. It gets you to where the prices of most things are and where inflation is. That’s important to understand what's been happening in inflation.
With that, we've seen data published for the month of July and published in the month of August, which we'll talk about in a moment. Back in our remarks on the 14th of August, we said that the RBA would not cut in September. That was at a time when the market thought there would be a September return. But we thought they would wait until November. So with the RBA leaving the cash rate unchanged on the 30th of September, is it still possible for a cut in November?
The RBA released its statement on 30th September, and that noted that recent data, while partial and volatile, suggests that inflation in the September quarter may be higher than expected at the time of the August Statement on Monetary Policy. So what are they talking about? What are they thinking about when they say that? Well, it could be that they’re thinking about the very sharp increases in electricity prices in the July and August monthly CPIs.
In the August monthly CPI, even with electricity prices rising by a stunning 24.6% for the year to August faster than the 13.6% for the year to July; the trimmed mean still fell from 2.7% in the year to July to 2.6% in the year to August. Now, a similar decline in September would take that annual inflation down to 2.4%.
The September quarter CPI will be released on the 29th of October. Should it show a trimmed mean of 2.5% or lower, then we think that the RBA should provide a rate cut in November. This would provide cheer for homeowners as we move towards the festive season. Still, it all depends on what we learn from the quarterly CPI on the 29th of October.
In recent days, several people have asked for my updated view on the Federal Reserve and the Fed funds rate, as well as the outlook for the Australian cash rate. I thought I’d walk through our model for the Fed funds rate and explain our approach to the RBA’s cash rate.
It’s fascinating to look at the history of the current tightening cycle. The Fed began from a much higher base than the RBA, and in this cycle, they reached a peak rate of 535 basis points, compared to the RBA’s peak of 435 basis points. For context, in the previous tightening cycle, the RBA reached a peak of 485 basis points.
The reason the RBA was more cautious this time around is largely due to an agreement between Treasurer Jim Chalmers and the RBA. The goal was to implement rate increases that would not undo the employment gains made in the previous cycle. As a result, the RBA was far less aggressive in its approach to rate hikes.
This divergence in peak rates is important. Because the Australian cash rate peaked lower, the total room for rate cuts and the resulting stimulus to the economy is significantly smaller than in previous cycles.
The Fed, on the other hand, peaked at 535 basis points in August last year and began cutting rates shortly after. By the end of December, they had reduced the rate to 435 basis points, where it has remained since.
Recent U.S. labour market data shows a clear slowdown. Over the past 20 years, average annual employment growth in the U.S. has been around 1.6 percent, but this fell to 1.0 percent a few months ago and dropped further to 0.9 percent in the most recent data.
This suggests that while the Fed has successfully engineered a soft landing by slowing the economy, it now risks tipping into a hard landing if rates remain unchanged.
Fed Funds Rate Model Update
Our model for the Fed funds rate is based on three key variables: inflation, unemployment, and inflation expectations. While inflation has remained relatively stable, inflation expectations have declined significantly, alongside the drop in employment growth.
As a result, our updated model now estimates the Fed funds rate should be around 338 basis points, which is 92 basis points lower than the current rate of 435. This strongly suggests we are likely to see a 25 basis point cut at the Fed’s September 17 meeting.
There are two more Fed meetings scheduled for the remainder of the year, one in October and another on December 10. However, we will need to review the minutes from the September meeting before forming a view on whether further cuts are likely.
Australian Cash Rate Outlook
Turning to the Australian cash rate, as mentioned, the peak this cycle was lower than in the past, meaning the stimulatory effect of rate cuts is more limited.
We have already seen three rate cuts, and the key question now is whether there will be another at the RBA’s 4 November meeting.
This decision hinges entirely on the September quarter inflation data, which will be released on 29 October 2025.
The RBA’s strategy is guided by the concept of the real interest rate. Over the past 20 years, the average real rate has been around 0.85 percent. Assuming the RBA reaches its 2.5 percent inflation target, this implies a terminal cash rate of around 335 basis points. Once that level is reached, we expect it will mark the final rate cut of this cycle, unless inflation falls significantly further.
So, will we see a rate cut in November?
It all depends on the trimmed mean inflation figure for the September quarter. If it comes in at 2.5 percent or lower, we expect a rate cut. The June quarter trimmed mean was 2.7 percent, and the monthly July figure was 2.8 percent. If the September figure remains the same or rises, there will be no cut. Only a drop to 2.5 percent or below will trigger another move.
We will have a much clearer picture just a few days before Melbourne Cup Day.
The Wall Street Journal of 21 August 2025 carried an article which noted that Ether, a cryptocurrency long overshadowed by Bitcoin has surged in price in August.
The article noted that unlike Bitcoin, there was not a hard cap on Ether supply, but the digital token is increasingly used for transactions on Ethereum , a platform where developers build and operate applications that can be used to trade, lend and borrow digital currencies.
This is important because of the passage on 18 July 2025 of the GENIUS act which creates the first regulatory framework for Stablecoins. Stablecoins are US Dollar pegged digital tokens. The Act requires that Stablecoins , are to be to be fully backed by US Treasury Instruments or other US dollar assets .
The idea is that if Ethereum becomes part of the infrastructure of Stablecoins , Ether would then benefit from increased activity on the Ethereum platform.
Tokenized money market funds from Blackrock and other institutions already operate on the Ethereum network.
The Wall Street journal article goes on to note that activity on the Ethereum platform has already amounted to more than $US1.2 trillion this year ,compared with $960 million to the same period last year.
So today ,we thought it might be a good idea to try and work out what makes Bitcoin and Ether go up and down.
As Nobel Prize winning economist Paul Krugman once said " Economists don't care if a Model works in practice ,as long as it works in theory" . Our theoretical model might be thought as a "Margin Lending Model" . In such a model variations in Bitcoin are a function of variation in the value of the US stock market .
As the US stock market rises, then the amount of cash at margin available to buy Bitcoin also rises .
The reverse occurs when the US stock market goes down .
Our model of Bitcoin based on this theory is shown in Figure 1 . We are surprised that this simple model explains 88% of monthly variation in Bitcoin since the beginning of 2019.
At the end of August our model told us that when Bitcoin was then valued at $US112,491 , that it was then overvalued by $US15,785 per token.
Modeling Ether is not so simple . Ether is a token but Ethereum is a business. this makes the price of Either sensitive to variations in conditions in the US Corporate Debt Market.
Taking that into account as well as stock market strength, gives us a model for Ether which is shown in figure 2.
This model explains 70.1% of monthly variation since the beginning of 2019. Our model tells us that at the end of August, Ether at $US 4,378per token was $US 560 above our model estimate of $US3,818.00 . Ether is moderately overvalued.
So neither Bitcoin nor Ether are cheap right now.
ETFs for each of Bitcoin and Ether are now available from your friendly local stockbroker .
But right now , our models tell us that neither of them is cheap!
There is more to what happened at Jackson Hole than just the speech by Jay Powell.
In my talk last week ,I said that our model of the Fed funds rate stood at 3.65%. This is actually 70 basis points lower than the actual level of 4.35%.
I also said that the Fed was successfully achieving a "soft landing" with employment growing at 1%. This was below the median level of employment growth since 2004 of 1.6%.
Still , as I listened to Jay Powell Speak , I noted a sense of concern in his voice when he said that "The July employment report released earlier this month slowed to an average pace of only 35,000 average per month over the past three months, down from 168,000 per month during 2024. This slowdown is much larger than assessed just a month ago."
My interpretation of this is that Chair Powell may be concerned that the "soft landing " achieved by the Fed may be in danger of turning into a "hard landing". This suggested a rate cut of 25 basis points by the Fed at the next meeting on 17-18 September.
This would leave the Fed Funds rate at 4.1%. This would mean that the Fed Funds rate would still be 45 basis points higher than our model estimate of 3.65%. Hence the Fed Funds rate would remain "modestly restrictive."
Dire Demography?
Jackson Hole was actually a Fed Strategy meeting with many speakers in addition to Jay Powell.
Two speakers who followed on the afternoon of his speech were Claudia Goldin, Professor at Harvard
and Chad Janis of Stanford Graduate Business School. They each gave foreboding presentations on the demography of developed economies.
Claudia Goldin spoke on "The Downside of Fertility". She noted that birth rates in the Developed World are now generally below replacement level. The Total Fertility rate is below 2 in France , the US and the UK.
It is dangerously low below 1.5 in Italy and Spain and below 1 in Korea. She observes that the age of first marriage of couples in the US is now 7 years later than it was in the 1960's. This reduces their child bearing years.
This paper was then followed by a discussion of it by Chad Janis of Stanford Graduate Business School. He noted that there is a profound difference between a future with a replacement rate of 2.2 kids per family , which he called the "Expanding Cosmos" with
• Growing population leading to a growing number of researchers, leading to rising living standards and Exponential growth in both living standards and population AND a replacement level of 1.9 kids per family which leads to
• Negative population growth , which he called "an Empty Planet " and the end of humanity
as numbers of researchers declines and economic growth ceases.
Of course this seems all very serious indeed . Perhaps what this really means ,is that if we want to save the world , we should just relax and start having a lot more fun!!
Today, we’re diving into how the Reserve Bank of Australia (RBA) sets interest rates as it nears its target of 2.5% inflation, and what happens when that target is reached. Back in 1898, Swedish economist Knut Wicksell published *Money, Interest and Commodity Prices*, introducing the concept of the natural rate of interest. This is the real interest rate that maintains price stability. Unlike Wicksell’s time, modern central banks, including the RBA, focus on stabilising the rate of inflation rather than the price level itself.
In Australia, the RBA aims to keep inflation at 2.5%. To achieve this, it sets a real interest rate, known as the neutral rate, which can only be determined in practice by observing what rate stabilises inflation at 2.5%. Looking at data from January 2000, we see significant fluctuations in Australia’s real cash rate, but over the long term, the average real rate has been 0.85%. This suggests that the RBA can maintain its 2.5% inflation target with an average real cash rate of 0.85%. This is a valuable insight as the RBA approaches this target.
As inflation nears 2.5%, we can estimate that the cash rate will settle at 2.5% (the inflation target) plus the long-term real rate of 0.85%, resulting in a cash rate of 3.35%. At the RBA meeting on Tuesday, 12 August, when the trimmed mean inflation rate for June had already dropped to 2.7%, the RBA reduced the real cash rate to 0.9%, resulting in a cash rate of 3.6%.
We anticipate that when the trimmed mean inflation for September falls to 2.5%, as expected, the cash rate will adjust to 2.5% plus the long-term real rate of 0.85%, bringing it to 3.35%. The September quarter trimmed mean will be published at the end of October, just before the RBA’s November meeting. We expect the RBA to hold the cash rate steady at its September meeting, but when it meets in November, with the trimmed mean likely at 2.5%, the cash rate is projected to fall to 3.35%.
