Coolabah's Christopher Joye: Australian inflation may re-accelerate in 2025

While risk-on assets like stocks and Bitcoin cheered the return of Donald Trump to the White House, one huge asset class didn't respond with the same kind of 'buy everything' enthusiasm. American government bonds sold off in the wake of Trump's victory, as those traders became concerned over how such a wide-ranging tariff policy, deregulation, and more widespread tax cuts would impact inflation, interest rates, and ultimately, economic growth. 

Trump's re-election is the bow on top of what has been another fascinating year in the fixed income markets. Rising bankruptcies and subdued interest rate cutting cycles across the developed world should have deterred investors from investing in risky hot asset classes like private credit. It didn't. 

Locally, the most startling development was APRA's unexpected proposal to phase out Aussie bank hybrids, a move that still has some investors wondering what comes next.

To get his views on how a second Trump administration will affect fixed income markets and where he is seeing the most risks ahead of 2025, we are joined by the one and only Christopher Joye, Chief Investment Officer of Coolabah Capital Investments.

The consequence of the news was to reduce repayment risks on hybrids, and so we immediately bought about $200 million of Aussie bank hybrids, which subsequently performed well. 

The plan also generates substantial negative net supply for subordinated Tier 2 bonds insofar as the circa $40 billion of hybrids will be replaced with only $22 billion of Tier 2 bonds. This is positive for that sector from a pure demand/supply perspective.

When you joined us for Views from the Top, we discussed how the Australian economy had not landed yet. Morgan Stanley has already said they aren’t willing to call a landing (soft or hard) for the Australian economy in 2025. 

Do you think we are any closer to knowing which landing the Australian economy will have?

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Christopher Joye: How investors can prepare ahead of a second "humiliating" RBA rate hiking cycle

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Joye: While we think it is possible the RBA starts cutting rates in February or May 2025, the inflation risks are skewed to stickier outcomes that make a sustainable return to the RBA 2.5% target challenging. This is amplified by fiscal dominance or the dynamic whereby governments around the world are running big budget deficits, which is making it harder for central banks to get inflation under control.

Australia’s economic story has become dominated by public rather than private activity as politicians spend crazy amounts of money to buy votes to win elections. 

Over the past year, government has accounted for an extraordinary 82% of all new hiring, leaving the private sector to take just 18% of jobs. It is like we are living in a centrally planned state. Back in 2000, the public sector only accounted for 22% of existing employment. Today that share has exploded to 31%.

A similar theme is evident in the composition of growth. Australia’s economy expanded by 0.8% over the past year. But more than 100% of that was made up by public spending. In the absence of all this public largesse, inflation and interest rates in Australia would be a lot lower.

We also believe that there are risks of a re-acceleration in global inflation in 2026 via the burgeoning US trade war, which would likely drive a sharp increase in US inflation.

You wrote recently in the AFR that interest rates could be higher under a second Trump presidency. 

What is the crux of that argument and what is the trade that goes with it?

Since Trump’s election victory, the messaging and narratives out of the Fed have shifted strikingly, immediately calling into question the need to lower interest rates further. 

It’s possible the Fed does not reduce rates in December, or, if it does, that this represents the final easing of this cycle, leaving us with a Fed funds rate of 4.25-4.50%. That would be about 100 basis points above our current estimate of the neutral rate, and circa 150 basis points beyond the Fed’s estimate of long-term neutral. 

This would create headwinds for cyclically sensitive sectors and riskier parts of the debt market that struggle under the weight of a heavier interest rate servicing burden. In turn, we would be shorting private debt and high yield if this scenario came to pass.

Paul Bloxham of HSBC is now arguing that the RBA may miss the easing cycle altogether. You have also written that investors should be aware of the threat of reaccelerating inflation. 

Do you think there is a genuine risk the RBA doesn’t cut interest rates at all in 2025?

I believe that the RBA has been somewhat politically compromised, and excessively dovish, keeping rates too low relative to peers overseas, and tolerating unacceptably high inflation vis-à-vis its own targets and the experience of other developed nations. Assuming the current government allows its cost of living subsidies to expire next year, there will be a mechanical acceleration in Aussie inflation. 

Australia’s challenge is that our state budget deficits are far too large, which in concert with extraordinarily strong population growth is creating excess demand.

We find that most of Australia’s economic growth since the pandemic, which has been superficially world-class insofar as it has returned to its pre-pandemic path, has been powered by the very blunt and costly instrument that is population growth.

Australia’s population increased by 2.3% over the last year, roughly 80% higher than its long-run trend. One has to look to countries in Africa and the Middle East to identify stronger population growth over this period. By way of contrast, US and European population growth is posting its poorest peace-time numbers since the end of the 19th century.

Which data point will provide the most important investing signal for 2025?

Joye: Nothing has changed since 2021: everything hinges on the path of US core inflation.

Finally - Tell us about a New Year’s resolution/a big personal goal you have for 2025.