Philip Brown, Head of Research at FIIG Securities, says there are ways to capture the benefits of an Australian economy moving towards an interest rate rise, and to also navigate the economic risks.
Are interest rates already restrictive?
We are very aware that the market is already pricing a little under two cash rate rises – and that would put us not far below the recent peak, which seems unnecessary. If the Reserve Bank of Australia (RBA) is raising rates while most other countries are cutting, each rate rise will hit the economy harder, which does suggest comparatively few rises will be necessary. It suggests the market is already pricing the full extent of the likely move, which makes now a good time to increase overall allocation to fixed income.
Managing fixed interest investments in a rate rise environment
Bond yields are much higher than they were only months ago and are providing opportunities for those looking to recycle or deploy capital. Floating rate bonds also look more attractive to investors.
Those with a longer-term outlook will probably find that the longer-term yields currently available are quite attractive. For example, bonds that are longer that currently have high yields are the Transgrid Aug-35 callable (6.11%*), or the Aurizon Sep-40 bullet (6.45%*).
Investors must decide whether they are happy to lock in attractive fixed yields and risk short-term volatility in the capital price, or if capital preservation is more important to them and they want to focus on floating rate notes and not have a guaranteed coupon rate.
Our strategy for 2026 is named RISE, designed to help investors capture the benefits of an economy with a likely rate increase, but to also navigate the risks of a slightly precarious economy:
R (Returns) – The market is assuming a decent period of rate rises, which may or may not occur, but will likely see periods where solid yields of 6% and more are available for low-risk bonds. Rising cash rates will also see floating rate bonds provide higher returns.
I (Inflation protection) – This can be either direct, via inflation linked bonds or IABs (Index Annuity Bonds), or more indirectly via the floating rate note market, which will benefit if inflation and cash rates rise together.
S (Sector Diversification) – There are quite a few pressure points in the economy. It is also likely that some sectors will come under pressure as the RBA seeks to raise rates to create space in the economy. It’s hard to predict where the contractions will come to make that space, so diversification is important.
E (Exchange rate exposures) – If the RBA is raising while the rest of the world is cutting, there is a chance of substantial volatility in the exchange rate. The Australian dollar is something of a sleeping risk. It has been very stable in the last few months between about 62 US cents and 67 US cents (with the exception of some weirdness around Liberation Day). However, with the RBA looking like it might be about to raise rates while many other countries are lowering them, including the US, it’s possible the AUD might become a little more unpredictable.
If the AUD does strengthen, then investments in currencies other than the AUD might suffer. This means that offshore investments need to be considered as an extra source of risk in the current environment.
Macro perspective: From rate cuts to rises, how did we get here?
The situation in Australia has changed quickly over the last three months. While we were never expecting a sharp rate cut cycle, we had previously been fairly confident that the general downwards trajectory for the RBA would hold for a long period. That is no longer guaranteed, with a rate rise at some point in 2026, even as soon as February, being plausible now.
How did the situation change so rapidly? There are a large number of crosscurrents in the economy at present and surprisingly little room to manoeuvre given the lack of spare capacity.
The RBA, along with most economists, politicians and thought leaders, has been hoping for an increase in productivity, which can really only happen with more investment. This is particularly true for an economy which has recently seen a large increase in the population and so requires an increase in the capital base to ensure that efficient relativities are maintained. A large investment in artificial intelligence to produce long-term improvements in productivity does seem the most likely way to achieve a material increase in productivity at the present moment.
The fact that there isn’t enough room for Government spending, private investment and a rise in household consumption simultaneously does not mean that the economy is poor. In fact, quite the reverse. But it does mean the economy might feel poor to the people in it.
If the only way to create space in the economy for the necessary investment cycle is for the RBA to raise rates so that household spending either falls or doesn’t grow, then it won’t feel like a good economy. That is one of the stranger crosscurrents in Australia at present: a boom that feels like a mediocre economy at best.
It’s also a dynamic that falls unevenly across the population as those with cash behind them benefit from higher rates, while those seeking to borrow (usually to purchase housing) find there is not much spare capital around at cheap interest rates. It’s why we’re talking about rate hikes when the consumer confidence figures remain relatively poor.
*Pricing correct as at 19 January 2026
