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 real GDP per capita growth plus my model of inflation expectations, the Wicksellian anchor, now 3.23 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 over 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
ReplyDeleteThanks Jase. Yes, and I think that’s the other half of the story. The post was mostly about the demand for capital: AI capex and fiscal deficits bidding for a global pool of savings. Your point is that the growth of that pool may itself be slowing.
DeleteThat’s essentially the argument Goodhart and Pradhan made in The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival (2020). Part of the saving glut of the 2000s came from Asia during an extraordinary combination of rapid growth, high saving, weak social safety nets and large current-account surpluses. Demography wasn’t the whole story, but it helped create a huge supply of capital that ended up in global bond markets. As those populations age, that force should gradually reverse.
There is an important offset: ageing also reduces investment demand. Fewer workers means less capital is required to equip them, so you can’t look at the saving side alone and conclude that r* must rise. The Goodhart-Pradhan argument is essentially that saving eventually falls by more than investment, which would push the equilibrium real rate higher. That’s plausible, but the size and timing are much less certain.
So I’d probably separate the horizons. AI investment and government borrowing look to me like the more immediate explanation for why the price of capital is rising now. Demography is a much slower-moving supply-side force that could help make that rise deeper and longer lasting.
Put differently: demand may be moving first while supply increasingly stops accommodating it. If both are happening at once, that strengthens the case for a structurally higher global r*. And for Australia, the important point is that neither side of that equation is determined here.