Happy Tuesday!

The RBA Board is meeting next week, and boy-oh-boy do they have some stuff to talk about.

I don’t want to say that inflation and unemployment have been cheating on the cash rate, but they’ve definitely been acting up and under-communicating (@Gen Z is this accessible?).

Let’s get into it.

Your questions, answered

The Reserve Bank of Australia (RBA) is meeting early next week to decide what to do with the cash rate.

Wondering what that means? Let me explain.

Let’s start with a quick refresh on the RBA’s objectives and how it meets those objectives.

The RBA has two goals:

Price stability: The rate of inflation stays around 2-3%.
Full employment: Everyone who wants a job can get a job.

The RBA uses the cash rate as a tool to achieve these goals. They forecast where they think inflation and employment are headed (based on current economic and financial conditions) and then they set the cash rate to make sure they head towards their goals.

So, when we think about what the RBA might do at the next meeting we have to ask ourselves three questions:

What is the RBA’s current forecast for inflation and employment?
How closely does that forecast align with the most recent data?
What does the gap (if any) between the forecast and the data imply for the cash rate?

So, what are the RBA’s current forecasts?

Here’s what the RBA is thinking:

Inflation is expected to hover around 2.5% until the end of 2027.
The unemployment rate is expected to hover around 4.3% until the end of 2027.

Importantly, these forecasts are made assuming the cash rate from 3.6% (where it currently is) to 3.4% by the end of 2025, to 3.1% by June 2026, and then hovers around 3% until the end of 2027.

So, if the data perfectly aligns with the RBA’s forecasts, we should expect the RBA to cut the cash rate at least once between now and the end of the year. There are only two more meetings this year: next week, and early December.

But, what is the most recent data saying?

This is where it gets a little more complicated. Unemployment and inflation are both higher than expected .

The RBA said that they expect inflation data for the September quarter to be higher than they expected. The ABS will release the data today at 11.30, so that will be a super important signal in predicting what the RBA does next week.

Also, the unemployment rate jumped up to 4.5% last month - which is the highest it’s been in 4 years and 0.2 percentage points higher than the RBA’s forecast.

What does that mean for next week’s meeting?

It looks like the RBA is getting caught between a rock and a hard place:

If inflation is higher than expected, then the RBA needs to increase the cash rate to bring inflation back down.
But if unemployment is higher than expected, the RBA needs to cut the cash rate to bring unemployment back down.

So, the RBA is getting mixed signals.

So, what will the RBA decide next week?

Well, a few weeks ago, before we got this new inflation and unemployment data, the odds whether the RBA would cut in November or December to stay on the assumed path were probably pretty balanced.

Now, it’s probably more likely they will cut next week (markets think there is a 70% chance of this happening).

We will have to wait and see.

The week’s biggest finance headline, explained

Last week, the ASX200 hit an all time high, surpassing 9100 points. This happened despite all the bad economic news, including low productivity, high tariffs, and slowing China, to name a few. What’s going on?

First, what do we mean by points?

The ASX200 is effectively a weighted average of the stock price for the 200 biggest Australian public companies, turned into an index.

Index means that we interpret changes in points as percentage changes in the weighted average stock price. So, if the ASX200 started at 9000 points, and goes up to 9900, that means that the stock prices for the biggest 200 companies in Australia went up 10%.

So why are stocks going up so much?

There’s a few reasons:

Lower interest rates: The RBA has cut rates three times this year, and so have foreign central banks, supporting share prices.
Strong investment cycle: Investors are feeling good. Stock prices tend to move in 3-5 year cycles, and we are in the middle of an up cycle.
Companies performance: Smaller-medium sized Australian companies are performing really well, particularly gold-mining companies and companies that mine rare earth metals (e.g., Lithium). The ASX200, which tracks the top 200 companies, is up nearly 30% over the past year, versus the ASX100, which is up only 10%. That tells us most of the growth is coming from the 101st to 200th biggest companies.
The banks: The big banks make up a huge portion of the ASX, and NAB, ANZ, and Westpac have all seen strong growth.

Is this just an Australian thing?

No. Stock prices in the US are also hitting record highs. They are also benefiting from positive investor sentiment, but there are also different factors at play. For example, tech companies have been seeing lots of growth (as opposed to small-medium sized mining companies).

Will this continue indefinitely?

Probably not. Here are two reasons to believe this momentum will not be maintained:

Historically high stock prices compared to profits: On average, investors are now paying about $22 for every $1 of company profit, compared with a long-term average of around $15–16. In other words, share prices have risen faster than company earnings, suggesting investors are more optimistic than usual about future growth. If prices are rising based on optimism, rather than fundamentals, there is a risk of a sharp correction when the optimism runs out.
Gold prices: Gold has climbed to record levels this year, rising about 60% since January. When gold prices surge at the same time as share prices, it usually means investors are enjoying the rally but still hedging against risk.

So what’s the bottom line?

Here’s the key takeaways:

Stock prices have been rising by quite a bit.
This is because companies have been performing well but investors are also feeling good.
There are some signs of cracks emerging.

A titbit for your group chat

Gold prices fell more than 5% last Tuesday, the largest daily drop since 2020.

Does this mean what I said above about gold is wrong? Probably not. The price of gold has increased so much this year, that a 5% daily tumble (though noteworthy) is a small correction against the backdrop of a strong rise.

But it does serve as a warning sign of what can happen when assets are over-valued.

💰 What will the RBA do next?