Australia's neutral rate is going up, and I think it stays up. Two charts.
Chart one: two proxies for nominal r*. The orange line is trend GDP per capita growth plus the 2.5% inflation target, the textbook Wicksellian anchor, now 3.24 and still drifting down. The blue line is the AOFM 5y5y risk-neutral forward, the bond market's guess at where the cash rate settles, now 3.87 and climbing since 2020. They disagree by half a point and the gap is widening.
Chart two is why I side with the market. Australian and US 5y5y forwards. For twenty years Australia paid a premium over the US, then ran a discount in 2019 to 2021 while the RBA lagged. Since 2022 the two have converged and moved together, month for month. AOFM 3.89, ACM 3.94. Australia's neutral rate is now set offshore.
That explains the divergence in chart one. The growth proxy is local: Australian output, Australian population. The forward is global: Australia is a small open economy that takes its risk-free rate from the world pool of savings and investment. Wicksell's natural rate is the return on capital, and trend growth is only a stand-in for it. When the global demand for capital shifts, the market proxy moves first and the growth proxy is left behind.
And the demand for capital has shifted. The AI buildout is absorbing capital on a scale not seen for some time, and it doesn't matter that most of it is in the US. Money is global. Stack heavy government borrowing on top, here and everywhere, and the price of capital has to rise. That is what the blue line is telling you, and Australian per capita growth has no vote.
Two consequences. First, the cash rate is 4.35, so on the market's reading the RBA is about half a point above neutral, not a full point. With a rising 5y5y, the RBA must lift the cash rate to maintain its fight on inflation. Second, the risk-free rate is the hurdle for every cost-benefit and ROI calculation in the economy. A nominal neutral rate near 4 means a lot of marginal projects that stacked up at 2 no longer do, and local capex will be rationed by a rate it has no say in.
As the old line goes, markets can stay irrational longer than you can stay solvent. But this isn't irrationality. It's a bond market pricing a world where capital is both global and scarce again, and that world could easily last the rest of this decade.
Great post My question would be whether the change in the availability of capital is also coming from the supply side and is the result of the end of the great econo-demographic boom in Asia. Ageing populations will draw down their savings (or pass them on to other generations) and smaller populations will have lower savings, while the normalisation of wealth might reduce saving, and lastly the slowing of growth further changes the trajectory of future savings supply fro the region
ReplyDelete