Posted by on
15/04/2025
There’s little doubt that 2025 has, so far, been action-packed in financial markets.
The return of Donald Trump to the White House, an RBA rate cut in February, the upcoming Federal Election and the announcement of sweeping tariffs by the USA in early April have all conspired to make volatility a feature of the markets this year.
The market for cash deposits has proven no exception to this volatility and is caught between competing influences. On the one hand, falling inflation and economic uncertainty have allowed the RBA to begin easing the cash rate. On the other hand, the breakdown of free trade globally has raised concerns about future inflation and caused interest payable on long-term securities like government bonds to rise.
In Australia, variable deposit rates are usually closely linked to what is happening with the RBA cash rate. Term deposit rates, while still influenced by what the RBA is doing, tend to be more closely linked to something called the swap rate. The swap rate is effectively a wholesale rate where banks can borrow from each other at a fixed rate for a defined period of time.
Swap rates for terms of 1-5 years have fallen sharply since the start of the year, which has prompted many banks to cut the term deposit rates that they offer to customers. Meanwhile, swap rates for a 10-year term are currently higher than they were in mid-December, and well above the most recent lows that were hit in September last year.
Seemingly, this suggests that financial markets are reflecting an expectation of lower inflation and lower interest rates (on average) for the next few years, but then higher interest rates in the distant future. This matches up with orthodox views of many economists who would suggest that the breakdown in free-trade could spark a global recession in the short term and lower inflation as goods that might have previously been shipped from China to the United States are dumped in other markets (like Australia) at very low prices.
Over the longer term, the breakdown in globalisation and free trade could pressure prices higher because efficiency is no longer being emphasised in production. Instead, countries seem to want to manufacture inside their own national borders to ensure security of supply chains, but this can come at the cost of efficiency. If we are producing fewer outputs with the same number of inputs, we may have a tightening in the supply side of the economy.
Lower supply results in higher prices unless demand is also lower. That’s where interest rates come in. The RBA and other central banks around the world set interest rates to contain price growth to around 2.5% per year. If the supply side of the economy is going to be weaker in the future, interest rates will likely need to be higher to keep prices contained.
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