Key Takeaways
- Diverging Peak Rates: The U.S. Federal Reserve reached a peak of 535 basis points, while the RBA peaked at 435 basis points to protect local employment gains.
- Economic "Soft Landing": Recent U.S. labour data indicates a slowdown, suggesting the Fed may need to cut rates to prevent a hard landing.
- Australian Cash Rate Outlook: Any move by the RBA in November is strictly dependent on the September quarter inflation data hitting 2.5% or lower.
- Limited Stimulus: Because Australia’s rates peaked lower than in previous cycles, the "room" for stimulatory cuts is more restricted.
- Real Interest Rate Target: Morgans models suggest a terminal cash rate of approximately 335 basis points once the RBA achieves its inflation target.
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 Fed funds rate model 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.
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. For investors, this makes portfolio administration and strategic asset allocation even more vital.
Fed Funds Rate Model Update
The Fed 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, it now risks tipping into a hard landing if rates remain unchanged.
Our Fed funds rate model is based on three key variables:
- Inflation
- Unemployment
- Inflation expectations
Australian Cash Rate Outlook
Turning to the Australian cash rate outlook, 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.
The Role of Real Interest Rates
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.
Will we see a rate cut in November?
It all depends on the trimmed mean inflation figure for the September quarter, which will be released on 29 October 2025.
- If it is 2.5 percent or lower: We expect a rate cut.
- If it remains at 2.7–2.8 percent or rises: There will be no cut.
We will have a much clearer picture just a few days before Melbourne Cup Day. In the meantime, keeping a close eye on market research is the best way to stay informed.
Contact a Morgans adviser today to discuss your strategy or find a financial adviser at one of our local branches.
Frequently Asked Questions
What is the Fed funds rate model?
The Fed funds rate model is a predictive tool used by economists to estimate the ideal interest rate based on economic variables like inflation, unemployment, and market expectations.
How does the U.S. economy affect the Australian cash rate outlook?
While the RBA is independent, U.S. trends signal global shifts. If the Fed cuts rates significantly, it can put upward pressure on the Australian dollar, which the RBA must consider in its own Australian cash rate outlook.
Why did the RBA peak at a lower rate than the Fed?
The RBA and the Australian Government prioritised high employment levels. By being less aggressive, they aimed to curb inflation without triggering significant job losses.
What is "trimmed mean" inflation?
Trimmed mean inflation removes the most volatile price increases and decreases. The RBA prefers this metric as it provides a more accurate view of long-term price trends.
What is a terminal rate?
The terminal rate is the point where interest rates are neither stimulatory nor restrictive. For the RBA, this is currently modelled at around 335 basis points.
How should investors react to rate predictions?
Investors should review their wealth management strategies to ensure they are positioned for a lower-rate environment, which typically supports equity markets.
Is a "hard landing" likely for the U.S. economy?
The recent drop in U.S. employment growth to 0.9% has increased the risk of a hard landing if the Fed does not continue to ease rates.
When is the next RBA rate announcement?
The next major decision point following the September inflation data will be the RBA board meeting on 4 November 2025.
