A tale of two journeys: Australia and the U.S.

In Australia, the Reserve Bank of Australia (RBA) is under pressure to increase interest rates further to contain inflation and achieve their objective of returning to the 2-3% target range. In contrast, the Federal Reserve (Fed) in the U.S. is on hold and seems generally satisfied with the progress they are witnessing; and have indicated that it's quite possible that their hike in July may very well be their last.

With high inflation, central banks faced the dilemma of how to respond. In this sense, the Fed set the standard, hiking the cash rate by 525 basis points since it began raising rates in March 2022. Whereas in Australia, the RBA only increased its cash rate by 425 basis points, starting three months after in May 2022, and subsequently moved at a somewhat slower pace than the Fed. While it is true that U.S. inflation picked up speed and reached a higher point than in Australia, the RBA's more cautious approach has resulted in growing pressure to effectively meet their goal of returning inflation to the target band by December 2025.

The graph below illustrates how the Fed's faster pace of rate hikes has seen inflation in the US to decline more quickly (to 3.7%) than here in Australia, where it stands at 5.4%.

With the RBA raising the cash rate again this month and stating at its November board meeting that “inflation in Australia has passed its peak but is still too high and is proving more persistent than expected a few months ago”, it wouldn’t be a surprise if they chose to increase interest rates again. Markets also believe this to be the case with futures markets pricing in an implied cash rate of just below 4.50%. (See chart below)

In contrast, at their meeting in November, the U.S. Federal Reserve decided to hold interest rates steady. Federal Reserve Chairman Jerome Powell justified this decision by saying that "slowing down is giving us, I think, a better sense of how much more we need to do, if we need to do more.". Powell also added that the bank would be "proceeding carefully" going forward. As a result, markets and number of analysts are calling this an end to further rate rise and market pricing in US is confirming this, with cuts predicted to begin in the first half of next year according to futures markets. (See chart is below.)

For investors seeking exposure to Australian bonds, we see investment grade credit as an attractive option given we retain our bullish thesis to owning local investment grade credit, discussed in our recent Q4 Outlook.

Allocating to Australian credit has been made easy through the iShares Yield Plus ETF ( IYLD), which is a short duration bond fund with approximately 1.3 years of duration. Alternatively, the iShares Core Corporate Bond ETF (ICOR) offers investors exposure to the broad Bloomberg AusBond Credit 0+ Yr Index. Both solutions will provide investors with a higher yield, more income, and lower levels of interest rate risk (i.e., lower duration) than investing in the broader AusBond Composite Index right now. 

For investors seeking exposure to global bonds and given the Fed’s latest meeting seeing them remain on hold and question whether they need to raise rates any further, we see allocating to U.S. Treasuries as one possible option, especially for those looking to add interest rate risk (i.e. increase duration) back into their portfolios. This would prove to be a good option should the Fed decide to start cutting rates over the course of next year and investors can gain exposure to U.S. Treasuries via our newest offering, the iShares U.S. Treasury Bond (AUD Hedged) ETF (IUSG).