Market review

October was characterised by an outsized lift in yields, driven from the US market. The Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, fell 1.88%.

Reassessment of US risks led a broad and strong uplift in yields through October.

Australia’s three-year government bond yields ended the month 48 basis points (bps) higher at 4.02%, while 10-year government bond yields were 53bps higher at 4.50%. Against the current cash target rate of 4.35%, three-month bank bills ended 2bps lower at 4.42%. Six-month bank bill yields ended 2bps higher at 4.64%. The Australian yield curve steepened modestly.

The market moved on from the easing cycle during October, reassessing the US economy’s resilience and finding it better than expected. The expectation of US Federal Reserve monetary policy reversed the prolonged easing, after strong US labour market data, and ongoing easing of economic concerns. This accounts for some of the lift in yields, but it was the changing odds of a Trump Presidency that completed the month-long outsized move. Betting odds showed a rise in probability of a Trump victory, although the outcome remains very close. The threat of a rise in tariffs, lower taxes and a rise in spending has markets pricing for more inflation and growth in the US economy, as well as more uncertainty. China is also expected to ease fiscal policy to boost their economy. Adding to uncertainty was the continuation of global conflicts.

The Australian bond market matched the rise in the global benchmark bonds, the US Treasuries. The spread to the US was relatively unchanged, suggesting more global rather than local factors. The rise in yield locally was in real yields, with more resilience expected in the local economy.

The economic data showed that the labour market was much stronger than expected, allowing the unemployment rate to dip to 4.1%. The forward indicators continue to point to moderation. Further analysis highlighted the strength in public sector spending in the three months to August, which may not be sustained. Private sector employment was weak, corresponding to the signals from insolvencies.

The long awaited Q3 CPI showed headline inflation moderated back to the Reserve Bank of Australia (RBA) target band, at 2.8% year on year (yoy). This was facilitated by various Government energy rebates, which are temporary, as well as lower fuel prices. The more stable trimmed mean inflation measure moderated to 3.5%yoy, from 4.0%yoy. Goods price growth is low, but services remain elevated.

Market outlook

The Australian economy is slow, and while no recession is forecast, the pressure of higher interest rates is broadening out across sectors of the economy. Core inflation is moderating slowly from high levels. The RBA needs to balance these risks along their so-called narrow path. The extended period of policy at restrictive levels will slow growth further, rebalance the labour market and subdue inflation. The global economic backdrop remains soft, although there are a myriad of risks which generate volatility.

Our base case is for the RBA to remain on hold at current rates before commencing an easing cycle in Q1 2025. We price a more modest than the historically average easing cycle, of around 110bps, spread across 2025. We presently have no tilt to the upside or lowside. The low case is for an earlier start, and more easing over the whole cycle. The high case looks for just 85bps of easing. The market has built in an RBA easing cycle, with only 53bps priced over 18 months. We believe there is value in targeted parts of the curve which outperform into easing cycles. We continue to hold a long duration position and look to adjust the position through market volatility.

Monthly focus – The push and pull of house prices

The housing market is at an interesting juncture, as two opposing forces come up against each other. The structural shortage of housing is well known, there is more demand than supply. However, affordability constraints are becoming more apparent and introducing the cyclical into prices.

The macroeconomic cycle and costs of servicing debt can outweigh even the largest structural gaps for short periods. Households continue to face relatively high mortgage rates, and payments. This has been sustained for an extended period and is now having a more pronounced impact on the residential housing market.

CoreLogic are reporting an increase in house sale listings, as mortgage holders look to sell before their capacity to meet payments are hampered. This was also highlighted in the RBA’s Financial Stability Report, where Liaison noted that more struggling borrowers are selling their homes.¹ Alongside the rise in listings, there is a drop in the number of people buying these homes, seen through a fall in the number of home sale transactions and auction clearance rates. This has started to show up in the CoreLogic data through a rise in the time on the market for houses for sale.

Inevitably, with a rise in homes for sales and a fall in demand, there is a moderation in price growth. This is not uniform across the capital cities, and the housing market is a segmented one, so there will always be differences; but overall, the tone is softening. Annual aggregate house prices are down from their recent peak of 9.7%yoy, to be at 6.7%yoy (Chart 1), but the range between the eight capital cities sees Perth at +24%yoy and Melbourne at -1.4%yoy.

Households are facing the worst of conditions at present, mortgage rates have been sustained for an elongated period and high inflation has diminshed their real disposable income. With the high cost of mortgage payments, and rent, housing affordabiliy is at its lowest since the data started in the 1990’s (Chart 2).

Assuming that the labour market will only weaken incrementally, we should see some further house price moderation but not to a troubling extent. This may broaden out across the states, so as the weakness frontrunners Melbourne, and Hobart, stabilise and the more robust markets, Perth and Adelaide join their peers in lower price growth.

This comes about as inflation moderates, disposable incomes rise and as households anticipate the RBA policy easing cycle. Households should become more confident that they can meet their obligations and sales volumes reduce. As the interest rate cycle moderates, the structural housing factors should return to the fore.

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