An overlooked opportunity in Australia

Growth paints a positive picture

“Resilience” characterizes the Australian economy in 2025. Demand has notably strengthened compared to 2024, with household spending rebounding and consumer confidence turning positive, supported by less restrictive monetary policy and ongoing fiscal measures. In the labor market, a modest increase in the unemployment rate to 4.3% in October reflects a healthy normalization from previously overheated conditions. This aligns with the RBA’s estimate of the “natural rate of employment” (the theoretical unemployment rate consistent with full employment) which is approximately 4.5%.

On the supply side, productivity growth has disappointed in recent quarters, resulting in capacity utilization rising above its long-run average. The imbalance between robust demand and lagging supply (aggregate demand refers to the total demand for goods and services within the economy, while aggregate supply represents the total output that producers are willing and able to provide at a given price level) has contributed to persistently elevated inflation, with the Q3 reading exceeding the RBA’s 2–3% target range. Of particular note is the breadth of the inflation impulse: over 50% of inflation components registered increases over 3%, marking the highest proportion since early 2024. Importantly, the inflationary pressure is both domestic in origin and broad-based, indicating a persistent and entrenched inflation profile for the foreseeable future.

The RBA easing cycle is the shallowest in G10

The Reserve Bank of Australia (RBA) held rates unchanged at 3.60% in a unanimous decision at the November meeting. We think the bank is moving to a neutral policy stance from this point, with a long hold or, at most, one additional cut in 2026. On the other hand, the bar for resuming rate hikes is also high even as inflation appears to be resurging, as the labor market is showing signs of cooling down. Provided that underlying inflation does not accelerate materially from current levels, the RBA would have enough bandwidth to keep rates on hold.

From a global perspective, this outlook put the RBA as a notable hawkish outlier amid the current synchronized easing cycle around the world. As major central banks such as the Federal Reserve and the Bank of England continue to cut rates into 2026, Australia’s terminal rate could end up being among the highest in the developed world.

Investment implications

From an FX perspective, our constructive outlook on the Australian Dollar (AUD) has remained intact since the beginning of this year. Over the first half of 2025, the AUD has steadily strengthened against a backdrop of broad dollar weakness. That momentum has moderated in recent months with AUDUSD hovering largely between 0.64 and 0.67, weighed down by weakness in oil prices. Compared with European G10 peers, the AUD is a relative laggard year-to-date. Looking ahead, we maintain a bullish stance on AUDUSD, underpinned by a favorable carry profile, resilient global risk sentiment, and signs of stabilization in oil prices. Our outlook range for AUDUSD over the next 6–12 months is 0.66–0.70.

For investors highly concentrated in USD and looking to diversify, Australian fixed income is an attractive option. Australian credit still offers one of very few asset classes where global investors can find USD-like yields, and its looking like these yields can persist for some time yet given the RBA’s outlook. The AUD bond market, though smaller in size, is recognized for its historical stability, driven by a predominantly buy-and-hold investor base and strong local support. Most AUD bonds are investment grade (IG), but still providing relatively high yields, with the 5-year benchmark AUD IG yield at 4.60%.

Compared to other developed markets, Australia’s fiscal situation is less of a concern, with a debt-to-GDP ratio below 50%. This prudent fiscal position has allowed the government to avoid significant increases in interest payments and has kept investor sentiment positive, without the need for a higher risk premium. Corporate issuers are mainly local companies, supplemented by foreign banks that swap AUD bonds to meet their funding needs. Notably, "Kangaroo bonds" – debt issued by foreign entities in Australian dollars – have been a major driver this year, accounting for 27% of new issuance.

We like Australia’s large banks and Global Systemically Important Banks (S-SIBs) issuing in AUD, as they are major issuers in the AUD bond market. These institutions provide high-quality, investment grade bonds and contribute significantly to the market’s depth and stability, making them attractive options for investors seeking reliable exposure to AUD-denominated assets.