What does the Fed rate cut mean for Australia? Will it make a difference whether or not the RBA follows suit in 2026?

Many investors will be asking themselves this question: ‘What does the Fed rate cut mean for Australia?’ This question is always asked, but the answer is a lot less concrete than it would ordinarily be, not least because Australia’s RBA will not follow suit, and may even go in a different direction.

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The Fed has cut rates

The Federal Reserve (or the Fed) lowered its benchmark federal funds rate by 25 basis points, bringing the target range to 3.50%–3.75%.

The decision reflects what the Fed described as a shifting balance of risks across its dual mandate: with signs of slowing in the labour market (weaker hiring, softer job growth) weighed against persistent inflation.

The cut is the third in a row this year — a move away from prior tightening, in response to evolving economic conditions. Fed chairman Jerome Powell acknowledged the tightrope between inflation and unemployment, noting there was no risk-free path.

But Powell, who has been head of the Fed since 2017, despite attempts to remove him, decided to make the third cut in as many meetings and said it was within a range of plausible estimates of a neutral rate.

Jerome Powell when the Federal Government tries to take him out of the Fed
byu/Ok-Tennis330 inwallstreetbets

As a dual mandate bank, the Fed is walking the tightrope

The Fed is one of the few central banks with a formal dual mandate, with that tightrope of juggling inflation and the labour market.

Many others, like the ECB, are focused primarily on inflation with any other outcomes (i.e. labour market outcomes) being secondary and only pursuable if they do not conflict with inflation control. All this being said, the Fed was evidently more focused on the labour market in making the decision.

Powell commented that layoffs and hiring were low, whilst households’ perceptions of job availability and firms’ perceptions of hiring difficulty continued to decline.

Importantly, at the news conference, Powell stated the Fed is “well positioned to wait to see how the economy evolves.” That suggests the Fed is not committing to an aggressive cut schedule, but rather tying future action to incoming data (inflation, jobs, growth) – even if investors think it is a fait accompli.

Remember that the internal vote was not unanimous: three officials dissented (one wanted a larger cut, two preferred no cut), underscoring divisions inside the Fed and while the Fed’s update ‘dot plot’ has one additional cut pencilled in, this is a slower pace than earlier in the year.

A range, not a target?

Before we go any further, we think we need to address a question Australian investors may have: Why there is a target range for interest rates rather than a fixed rate?

It is complicated, but it boils down to the fact that the US system is so much more larger and complex that one single rate would be more difficult. The Fed cannot perfectly pin one rate, but it can set floors and ceilings, and this is what the range is.

Ironically, the Fed used to have a fixed rate prior to 2008, but found that after quantitative easing flooded the system with excess reserves, hitting any single number would be impossible without large daily interventions. So here we are with the current system.

In Australia, its banks and other Authorised Deposit Taking institutions trade reserves in a system that is small, simple, and tightly controlled — so the RBA can hit a single number for interest rates precisely in the way the US Federal Reserve cannot.

So what does the Fed rate cut mean for Australia?

This is a good question and a lot of it may boil down to what the RBA does. But with the RBA not meeting until next year, there will be some impact. We could expect the AUD to strengthen because US yields fall when the Fed cuts rates, and lower US yields make American assets less attractive and the US dollar weakens. And this in turn would cause the impacts which a stronger AUD naturally has in lower import costs but higher export costs.

Moreover, lower US rates would push investors to higher-yielding countries. Even if Australia does not hike rates for the forseeable future, yields would be more attractive and this could cause the AUD to go higher.

But could the RBA’s next step have an impact?

It is quite rare that the RBA goes in the opposite direction to the Fed when it comes to interest rates. If this scenario eventuated, the impact would be different from the scenario where both the Fed and RBA cut rates around the same time.

If the RBA follows the Fed in cutting rates; then the AUD may stay relatively stable (because yield differences remain similar), domestic borrowing costs fall which is good for households and businesses; and nflation pressures may ease but the impact will depend on domestic conditions.

This is a so-called “neutral divergence” outcome: Australia stays aligned with global monetary trends.

What if the RBA hiked rates in 2026 while the Fed stayed on its current course

We already mentioned the impacts the RBA simply staying put would have. But what if the RBA hiked interest rates? Many of the same impacts would happen, but they would be magnified.

We’d expect a particular appreciation of the AUD vs the greenback (the US dollar). Of course, domestic financial conditions would tighten, and this could slow the economy materially – then again, that is the very point of hiking rates.

Global investors would most likely buy Australian bonds due to higher yields, which would push yields down at longer maturities, even if the RBA hikes at the short end. At the same time, this is no guarantee.

Investors may avoid Australia because of worries that the RBA has conceded inflation is out of control (by hiking interest rates) and is willing to sacrifice growth to get inflation down. Australia would be far from the only country with a higher rate than the Fed, but perhaps one of the few still battling inflation.

Conclusion

Australians will be left to wonder all summer where the RBA will go to next on interest rates, but hiking rates is a possibility even if it would be a totally different course to the US Federal Reserve.

While the RBA has always (of course) followed its own course, it would be a unique scenario when it is going the polar opposite direction and begs the question of what would happen.

To make a long story short: many of the impacts that always happen when rates are higher in Australia than in the US would be magnified. This is the most plausible scenario, although the prospect of investors choosing other jurisdictions to invest in (i.e. those with inflation under control but still having higher rates than the US) cannot be entirely ruled out.