Why the ASX doesn't need more rate cuts to keep rising

The RBA may have finished cutting interest rates, but UBS argues the current economic backdrop remains supportive enough to sustain equity markets without additional monetary easing.

The RBA kept interest rates on hold last week and tempered expectations for further rate cuts at its 4 November meeting. Governor Michele Bullock explicitly said the "board is definitely targeting 2.5% inflation” and even inflation “just below 3 is not good enough."

In response to the new hawkish outlook, "do not expect any more cuts this year from the RBA and the bar to any further easing next year is extremely high," wrote AMP Economist My Bui in a note last week.

Despite the downbeat rate outlook, Australian household spending is currently growing at 5.1% year-on-year, sitting above its average of 4.8% since 2013, according to UBS. This suggests consumers are already responding positively to the three rate cuts delivered by the RBA since February.

Consumer momentum persists

UBS's latest quarterly consumer survey delivered the strongest results on record, with respondents indicating plans to accelerate spending over the next 12 months. The surge in discretionary spending intentions was most pronounced among middle-income earners. Respondents were also mixed on their rate expectations, with a healthy segment either anticipating no change or even rate rises over the coming year.

Meanwhile, the latest Westpac consumer sentiment index for November unexpectedly surged 12.8% to 103.8. This marks the first positive (above 100) reading since February 2022 and strongest in seven years, excluding the pandemic.

Source: Westpac Economics

The takeaways from the survey include:

• Gains were driven by economic optimism, with the 12-month and 5-year outlook sub-indexes up 16.6% and 15.3%, both now well above long-run averages.

• Confidence lifted despite higher inflation and rate concerns, aided by the RBA’s dovish tone in November and signs of domestic recovery in housing and demand.

• The ‘family finances next 12 months’ sub-index rose 12.3% to 109.1, though current finances remained weak at 85.2, underscoring a gap between optimism and lived reality.

• The ‘time to buy a major item’ measure jumped 14.9% to 111.6, a four-year high, hinting at a possible lift in retail spending heading into Christmas.

UBS says the three rate cuts delivered this year have yet to fully transmit through to consumers, meaning the benefits are still building even as the cutting cycle ends.

Structural shift in rate sensitivity

Australian equities have become progressively less sensitive to RBA policy moves in recent years. UBS attributes this to wealth effects and demographic shifts that have dampened the amplitude of rate cycles.

Australian companies now generate a larger share of earnings from offshore markets, reducing their dependence on domestic monetary conditions. This structural shift means RBA policy carries less weight for equity performance than it once did.

Historical context points to mid-90s analogue

UBS sees the closest parallel to current conditions in the mid to late 1990s. Both periods featured a relatively sound domestic economy coinciding with a technology-driven bull market in global equities.

Source: UBS

There's no standard playbook for how equities respond to rate cycles, though the motivation behind rate moves matters. The 2008 cycle, driven by collapsing global growth, saw equities plunge despite aggressive easing. The 1996 experience more closely mirrors today's conditions.

RBA-Fed divergence

While the RBA pauses, the Fed is expected to cut 25 bps by year end and another 25 bps by June 2026. The last time these central banks diverged so sharply was in 2002, when the Australian dollar rallied 32% over 18 months.

Episodes of Australian dollar strength have historically favoured local equities over global peers, with mining stocks showing the strongest positive correlation to a rising currency. Given Australia's current terms of trade and commodity exposure, this dynamic could provide support for the local market.

Sector implications

Real estate and retail stocks have been clear beneficiaries of the recent dovish shift. But with the easing cycle likely over, this tailwind has quickly dissipated. Since 28 October, the S&P/ASX 200 Real Estate and Discretionary indices have dipped as much as 7% and 9% respectively.

Source: UBS

However, UBS says that stable rates don't automatically create headwinds. They maintain Neutral ratings on both Consumer Discretionary and Real Estate sectors, suggesting equity sector selection may now detach from the rate trade.

The bottom line

UBS's analysis suggests investors shouldn't abandon Australian equities because the RBA has stopped cutting rates. The combination of resilient consumer spending, supportive fiscal policy, lagged benefits from previous cuts, and reduced sensitivity to domestic rates creates a more nuanced outlook.

The domestic economic backdrop remains relatively healthy, particularly compared to some other developed economies. While a scenario of falling rates and solid growth would be ideal, the absence of further easing doesn't preclude positive equity returns.

For investors, this means maintaining exposure to quality Australian equities whilst being selective on sector positioning. The rate-sensitive trade may have run its course, but opportunities remain across the market.