Strategy commentary cont'd: In the 2024 YTD there has now been A$21.4bn of AUD issuance of Tier 2 bonds, which is 54% higher the previous record of A$13.9bn. One part of this story has been foreign or "Kanga" issuers supplying the AUD Tier 2 market with A$5.85bn of issuance in 2024 YTD compared to $1.8bn in the prior four years combined.

As a result of higher credit spreads, Coolabah's strategy yields improved in November, as the chart immediately below highlights.

Coolabah's fixed-rate (or long duration) strategies generated healthy returns in November. Our AAA rated, daily liquidity Active Sovereign Bond Fund returned 1.57% net of fees in its 5.3 year fixed duration unit class (benchmarked against the AusBond Treasury Index's 1.17%).

The sovereign strategy was launched at the end of 2022 and is now starting to generate considerable momentum, outperforming its benchmarks and known peers since inception.

In November, the recently launched Active Global Bond Fund, which has an average A- rating and 6.0 years duration, returned 1.43% after fees, besting the benchmark Bloomberg Global Aggregate Corporate Index's return of 1.32%.

Coolabah's A+ rated Active Composite Bond Fund (ETF: FIXD), which carries 5.1 years duration exposure, returned 0.99% after fees in November, lagging the Composite Bond Index's 1.14% following some exceptionally strong FIXD alpha in October. Over the 12 months to November, FIXD has returned 8.4%, outperforming the index's 5.2% by a nontrivial 3.2% after all retail fees.

Coolabah's floating-rate or near-zero duration strategies posted more modest returns due to wider credit spreads and the absence of any assistance from the fixed-rate duration rally. One exception was the near-zero duration unit class offered within Coolabah's Active Sovereign Bond Fund, which returned 0.8% net compared to the RBA cash rate's 0.3%.

The daily liquidity, A+ rated Long Short Credit Fund returned 0.3% after fees in November and has delivered 10.1% to 10.4% net over the last 12 months.

The daily liquidity, A+ rated Floating-Rate High Yield Fund returned 0.2% in November and has offered 9.4% to 9.7% net over the past year.

Coolabah's lowest volatility strategies, the daily liquidity, A+ rated Smarter Money and Short Term Income funds, furnished 0.3% net in November and have returned between 6.0% and 6.3% over the last year after all fees.

Past performance is no guide to future returns. Please read the product PDS to better understand its risks. Investors should also seek independent financial advice.

Strategy commentary cont'd:

Could the RBA cut interest rates in February?

Interest rate relief in Australia may be coming faster than markets think. The October monthly gauge revealed an unwelcome 3.5% core, or trimmed mean inflation over the 12 months to October. The Reserve Bank of Australia is hoping to return core inflation to the 2.5% midpoint of its target band by late 2026.

The October outcome was notably higher than both the 3.2% annual reading in September and economist expectations. The details were also disconcerting. While goods prices have finally started declining in Australia thanks to supply chain normalisation, the all-important – and substantially more structural – services inflation has remained stubbornly sticky at circa 4% to 4.5% since the end of 2023.

And the bad news on goods prices is that we are now facing the advent of an international trade war between the US, China and other countries caught in the crossfire. This will inevitably put upward pressure on global inflation in the immediate term, which will make it much harder, at the margin, for central banks to ease interest rates.

It is difficult to foretell precisely how the burgeoning trade war will unfold. After Donald Trump announced he was slapping a new 35% tariff on all Chinese imports, one would expect his adversaries to retaliate in kind by further restricting access to China's essential exports of rare earths, which are critical components in many US high-tech devices.

China produces 60% of the global supply of rare earths, processing almost 90%. In late 2023, it limited the export of gallium and germanium, which are required in electronics and fibre optics, and the supply of high-grade graphite, which is needed for lithium-ion batteries. It has also recently placed constraints on the sale of technologies to make rare earth magnets, to extract and divide rare earths, and to produce rare earth metals and alloys.

The reduction in global inflation has been mostly powered by falling goods prices as supply chains reopened following the pandemic lockdowns. The inception of this new Trumpian trade war could reverse that dynamic.

Strategy commentary cont'd: The good news according to Barrenjoey's rates strategist Andrew Lilley is that there is evidence that the rolling quarterly pace of core inflation in Australia, which he measures monthly, has attenuated sharply. More precisely, Lilley's estimate of this benchmark fell to within the RBA's target 2% to 3% band in October for the first time in years.

"On a quarterly basis, underlying inflation has – at a surprising pace – come back within the 2% to 3% target band," Lilley says. In particular, it has fallen from a peak of 1.21% in September 2023 to just 0.65% in October 2024 on Lilley's calculations.

The Barrenjoey' rates strategist is now forecasting that the very important official fourth-quarter core inflation numbers in Australia will come in at only 0.5%, which would be a material downside surprise relative to the RBA's latest projection of 0.7%.

"Based on our historical misses on trimmed mean, we can project [a circa] two-thirds chance that trimmed mean will print at 0.5% or below and a 30% chance that trimmed mean will print at 0.4% or below," Lilley says.

In the event that the December quarter core inflation results are as low as 0.4%, Lilley reckons the RBA will commence cutting interest rates in February, "irrespective of their prior guidance".

Statistically, he believes there is now a "90% probability that trimmed mean inflation in the fourth quarter will be below the RBA's forecast, and at or below the midpoint of the target band".

If we do get a softer-than-expected 0.4% or 0.5% outcome for core inflation in the December quarter, the six-month annualised pace would have declined to 2.4% to 2.6% (down from 3.3% in the September quarter).

Now the RBA has warned in its latest board minutes that it will not be swayed by one quarterly print. But a sufficiently weak result could, as Lilley asserts, compel them to cut irrespective of their prior guidance, putting a possible February move well and truly in the crosshairs.

They will doubtless come under tremendous political pressure to act before the next federal election, which will have to be held before May 17, with pundits such as Phil Coorey suggesting a target date could be April. And if we have learnt anything at all about the current incarnation of Australia's central bank, it is that it is prone to wilt when bullied by its political masters.

Remember governor Michele Bullock's claim that out-of-control public spending was not the main game with respect to cauterising Australia's demand-side inflation crisis – because the treasurer was hell-bent on quashing it via prudent fiscal policy settings? Yet the RBA's own researchers subsequently declared that rampant government largesse was, in fact, one of the biggest drivers of the country's capacity constraints.

Then there was Bullock's testimony that the RBA could keep interest rates lower than peers overseas because monetary policy is more potent here given the unusually high household dependency on variable-rate mortgages.

Just this month one of the RBA's assistant governors, Chris Kent, eviscerated Bullock's proposition by declaring that, "the effect of monetary policy is neither faster nor more potent in Australia than elsewhere". (See more on this below.)

The parlous state of our public finances was underscored by rating agency Standard & Poor's shocking markets with a threat to downgrade NSW's AA+ credit rating. It has already pulled the trigger once since the pandemic when it swiped NSW's AAA rating in late 2020.

"Our previously forecast structural improvement in NSW's budgetary performance has not materialised since the pandemic due to strong government spending," S&P stated.

"We now forecast that NSW's after-capital account deficits will not narrow for another two years. Our very strong assessment of NSW's financial management capability could weaken if the state does not rein in growth of operating expenditure, narrow its after-capital account deficits, and ease its growing debt burden as promised in its 2024-25 budget."

Strategy commentary cont'd: The world's most influential rating agency warned that it had "revised the outlook on our long-term rating on NSW to negative from stable", which is a potential harbinger of a future downgrade to AA or AA-. If this came to pass, the biggest Australian state would carry a similar credit rating to the four major banks, which currently pay substantially higher interest rates on their debt than NSW does.

Prior to the pandemic, NSW owed the world $62 billion. But in 2020, the state's politicians started spending like crazy because the RBA told them they were committed to not lifting interest rates above 0.1% until 2024.

In late 2021, NSW was still only paying less than 1% in annual interest on its 10-year borrowings. By 2028, NSW says it will owe the world about $250 billion, or four times as much as it had borrowed in 2019.

The problem is that the interest rate on new 10-year NSW debt has jumped from circa 1% in 2021 to more than 5% today. As the cheap debt from the pandemic rolls off and is replaced with much more expensive finance, NSW's annual interest bill could rise to north of $12 billion.

It makes you wonder about the much higher taxes future generations will have to pay to service the debt racked up by myopic politicians addicted to spending other people's money to financially conflict voters in a desperate attempt to win elections. We are stealing from future generations in order to bail out those hedonists who populate in the present.

RBA: "No evidence that monetary policy overall is more potent in Australia"

RBA Assistant Governor (financial markets) Kent recently spoke on the financial system and monetary policy.

Importantly, he acknowledged that, "... the effect of monetary policy is neither faster nor more potent in Australia than elsewhere", adding that "[while] the effect of interest rates on the cash flows and behaviour of indebted households receives extensive attention in Australia [it] is only one side of the cash-flow channel, and that, in turn, is only one of the channels of monetary policy transmission".

This is a point that CCI has long made, despite the widely-held market belief the interest rates are more effective in Australia because of the cash flow effect on heavily-indebted households, something that has periodically coloured the RBA's own commentary on the economy.

This point also gels with analysis showing that monetary policy in Australia has not been particularly tight relative to history, with policy less restrictive than other advanced economies that have made more progress in bringing inflation under control, where some other central banks are now cutting interest rates.

On financial stress, Kent mentioned that, "Despite the substantial increase in mortgage payments, there has been little increase in acute financial distress among borrowers. Mortgage arrears rates have risen, but they remain low and at similar levels in Australia and the United States", with households still adding to mortgage buffers.

However, corporate insolvencies have picked up, which Kent thought was driven more by factors other than interest rates – "while company insolvencies have increased over the tightening phase, this largely reflects factors beyond the direct effects of higher interest rates" – where it is true that the use of fixed-cost contracts was a catalyst for many construction companies going broke.

Finally, Kent talked about the reluctance of the RBA to follow its peers and offer explicit forward guidance on interest rates, stating that, "Outside the pandemic episode, the RBA has tended to provide forward guidance that is more infrequent, short-term and qualitative than many other central banks. I have outlined some of the arguments for this, but I think it would be worth reviewing the RBA's approach to forward guidance from time to time, including to consider other ways that the RBA might clarify the nature of its reaction function. Any such reviews should carefully account for features of Australia's financial system that set it apart from other economies."

Strategy commentary cont'd: Note that the RBA did not broadcast the speech, suggesting that it will publish audio of the Q&A session tomorrow, which presumably will include questions about the economic spillover of Trump policies to Australia.

RBA: Policy not as tight as peers, which is why inflation is higher

With the year almost over, the RBA kept the cash rate steady at 4.35% in November, having last raised rates twelve months ago.

The RBA also issued an updated outlook that was little changed from August, showing a slow return of underlying inflation to the 2.5% midpoint of the inflation target in late 2026.

The slow return of inflation to target reflects the well-known choice by the RBA not to raise rates as much as other countries in order to preserve as many of the COVID-era gains in the labour market as possible.

Interestingly, the RBA was more explicit in highlighting this trade-off in two charts in its Statement on Monetary Policy.

The first chart shows how Australia's monetary policy – as measured by the policy rate less the neutral rate – is not as tight as other countries, even with some other central banks already cutting rates.

The second chart shows that less tight policy has meant that underlying inflation in Australia is higher than nearly all its peers, where lower inflation elsewhere has allowed other advanced economies to start cutting rates sooner.

CCI has previously made the same points, such that the RBA has less scope to cut rates than other countries if it achieves a soft economic landing for the simple fact that it never raised rates by as much as in the first place.

The RBA shows that policy is not as tight as other countries, such that underlying inflation is still high