A tale of two central banks

Charles Dickens started his celebrated 1859 novel A Tale of Two Cities with one of the most enduring opening lines in literature: 

"It was the best of times, it was the worst of times."

More than 150 years later, it seems an apt description of the strange duality facing the RBA and US Federal Reserve, both of whom have significant rate decisions this week. 

After a chaotic year, both economies are in relatively good health. And yet the same dark clouds still loom over both, even as their central banks are almost certain to diverge on rates this week. 

On Tuesday afternoon, the RBA held the cash rate at 3.6%, as widely expected. "It was appropriate to remain cautious", was the view of the RBA board. 

On Wednesday, the Fed is likely to cut rates, with CME's FedWatch tool suggesting an 87% chance of a 25-basis-point cut. 

It paints a certain picture of the two economies - one overheated and on a knife-edge, and one simply in need of a little pick-me-up. 

This narrative has certainly resonated with investors. It's part of the reason the ASX has flagged since October, while the S&P 500 has clawed its way back to near all-time highs. 

And it's a narrative that looks like it will still be around into 2026, even if the underlying story is the same for both countries.

In Australia, many see yesterday's hold as a book-end to the RBA's rate-cutting cycle. That is certainly the opinion of CBA, NAB and ANZ, who have all ruled out any further rate cuts, even as Westpac and Morgan Stanley forecast two rate cuts in 2026. 

RBA governor Michele Bullock certainly poured cold water on cuts in the near-term, telling a press conference that "I don’t think there are interest rate cuts on the horizon for the foreseeable future."

More significantly, money markets are now pricing in a rate hike by the end of 2026. 

But while markets, investors and mortgage holders keep their fingers crossed for more rate cuts, there's an argument to say Australian interest rates are actually right where they need to be. 

Unemployment is stable, inflation has picked up but isn't disastrous and Australian GDP grew 0.4% in the September quarter. Yet productivity remains a going concern, and the worsening housing crisis complicates the rate situation further. 

Despite the noise from money markets, further rate cuts are not out of the question. "While recent data has been firmer than expected, it’s premature to conclude that the easing cycle is over," said Adam Bowe, Pimco's Head of Australia Portfolio Management.

Either way, things are finely poised, and a significant shift on any of the RBA's key metrics could move the needle, which is at the heart of the dilemma facing the RBA.

Things are simultaneously good and bad - the best of times and the worst of times - even as the narrative insists on the latter. 

On the face of it, the Fed has a more straightforward task. 

Unemployment rose to 4.4% in September, the highest level since 2021, amidst widespread job cuts. While the Fed's preferred inflation measure, the PCE index, also rose to 2.8%, it is expected to cool in 2026. 

But the Fed faces big questions of its own, even as it looks set to lower interest rates for the third successive time this week, to 3.75-4%.

Many are also predicting further rate cuts in 2026. Goldman Sachs Research forecasts the Fed will deliver cuts in March and June, bringing the funds rate down to 3-3.25%. 

The recent government shutdown, the longest in US history, has delayed the publication of key data - namely, November hiring data and the most recent inflation data - and the FOMC members, who vote on rate decisions, remain publicly divided. 

It means that the US economy currently exists in a quantum state. Like Schrodinger's Cat, it's both healthy and sick until proven otherwise. 

It's also left the Fed between a rock and a hard place. As Fed chair Jerome Powell said in October, “What do you do if you’re driving in the fog? You slow down."

The Fed has also faced increasing pressure from the White House to keep cutting rates, and President Trump is likely to tighten his grip over the next year when he appoints Jerome Powell early next year.  

So while the prevailing narrative suggests the RBA has been forced to turn hawkish as the Fed turns dovish, beneath the noise, the outlook is remarkably similar. You have two economies in decent health, facing similar uncertainties and challenges, but making different moves on rates. 

And the dilemma remains the same for both central banks. It is the best of times and the worst of times. 

As they look to tackle this economic duality, they could do worse than consider the oft-forgotten next line in Dickens' iconic opener: 

"It was the age of wisdom, it was the age of foolishness."