Source: Airservices Australia
I would like to begin by acknowledging the Gadigal people of the Eora Nation, the traditional custodians of the land we are meeting on today. I pay my respects to their Elders past and present. I also extend that respect to all Aboriginal and Torres Strait Islander peoples joining us today.
It’s a privilege to be here at the Australian Securitisation Conference.
A key role of International Department at the RBA is to provide advice on developments in international financial markets to the Monetary Policy Board and to work with colleagues across the RBA to interpret what these developments mean for financial conditions in Australia.
The aim of my talk today is to provide a flavour of how we do this. I’ll recap some key developments in international financial markets over the year and then explain our framework for thinking about how these developments can affect financial conditions in Australia, focusing on the distinctive features of the Australian financial system that shape the transmission of global financial market shocks.
In the interest of time, I won’t cover other important international linkages, including economic transmission channels, where global financial conditions affect global activity that transmits to Australia, or the transmission of shocks during periods of financial stress or market dysfunction. These have been covered in other recent RBA publications and speeches.
The year in review
This year has certainly been eventful. The global financial system has been affected by a convergence of interrelated forces. Policy uncertainty has at times been extreme as the US administration has disrupted established policy norms (Graph 1). Concerns about global fragmentation have been heightened. But despite some bouts of volatility in markets, including in recent days, risk premia have been low, fuelled by optimism about AI, more supportive policy settings and as the more adverse scenarios for global growth have not materialised.
Central banks have eased policy rates cautiously …
Central bank policy rates are one of the most important determinants of global financial conditions. Almost all central banks in the major advanced economies reduced their policy rates in 2024 and 2025 as inflation eased from post-pandemic highs and labour markets cooled. Japan was the exception, gradually tightening monetary policy in response to inflationary pressures after decades of very low inflation. Most central banks have taken a cautious approach as they have navigated the extreme policy uncertainty and while inflation remains a little above their targets due to sticky services inflation. Market expectations are for further gradual policy easing in some advanced economies over 2026, most notably in the United States (Graph 2).
Central banks have also continued to run down their balance sheets, in a way designed not to impact financial conditions meaningfully. Some have concluded, or signalled they are close to concluding, this process. The US Fed recently announced it will end its balance sheet run-off in December. This reflected a judgement that reserves were nearing ‘ample’ levels, given signs of pressure in a range of US money market rates.
… amid concerns of increased global fragmentation.
The potential for global fragmentation has been a major theme of 2025. Over the second half of the 20th century and most of the 21st century to date, increasing global integration has supported growth in advanced and emerging economies. This was underpinned by policies that have made it easier for goods and services, capital and ideas to flow across borders.
However, support for such policies has been waning for a number of years in the United States and elsewhere, in large part because the gains were not always distributed evenly. Inequality, including between regions, and the post-pandemic surge in inflation, which reduced real incomes, has provided impetus to growing political polarisation and nationalism. At the same time, geopolitical tensions have been rising.
Protectionist policies have the potential to cause a retrenchment of global trade and capital flows that would undermine welfare globally. The risk of regulatory fragmentation across the international financial system has also been increasing, as jurisdictions pursue diverging regulatory priorities, including in banking and digital assets.
The good news is that a retrenchment of global trade and capital flows has been more of a fear than a reality in 2025, at least so far (Graph 3). Capital flows, including into the United States, remain high. Global supply chains have been surprisingly resilient and adaptable, perhaps drawing on the lesson of the pandemic. Effective US tariff rates, while still much higher than at the beginning of the year, are lower than originally feared in April. The AI infrastructure boom has also supported trade, and by more than many expected.
Questions have been raised about the US dollar’s ‘safe haven’ status …
The role of the US dollar in international markets has received some attention this year. Concerns about the US administration’s policies, including the potential for lasting damage to key institutions, have led some commentators to question whether the US dollar can maintain its longstanding ‘safe haven’ or reserve currency status. Typically, the US dollar strengthens when global aversion rises, but after the April tariff announcements, the US dollar depreciated, while US Treasury yields spiked and equities fell (Graph 4).
Overall, the concerns about the status of the US dollar seem to have been overstated, at least for now. There are currently no clear alternatives to the US dollar as the world’s dominant currency. While the US dollar has depreciated by 6 per cent on a trade-weighted basis over 2025, this was from a near historical high at the end of 2024. Much of the depreciation can be explained by standard macro determinants, including narrowing interest rate differentials between the United States and the rest of the world.
Foreign reserves of central banks and governments have not shown an accelerated move away from the US dollar in 2025. The US dollar’s share in official foreign exchange reserve portfolios continued to decline gradually this year, consistent with the trends of recent years (Graph 5). But the decline in 2025 is mostly explained by valuation effects from exchange rate movements. It has not reflected a generalised reallocation away from US dollar assets in reserve managers’ benchmarks.
There is also little evidence of a significant reallocation away from US dollar assets by other asset managers. Nevertheless, there is evidence that some market participants are looking to manage increased risks around the US dollar. Market reports and our own liaison indicate that some non-US asset managers have increased their hedging of US dollar assets even though it is relatively costly to do this when US interest rates are higher than elsewhere.
… and concerns about fiscal dynamics in some countries have put upward pressure on sovereign bond yields.
Fiscal dynamics have been in focus in a number of economies overseas. The cumulative impact of responses to the global financial crisis and the pandemic have left gross government debt ratios higher (Graph 6). In some countries, political polarisation is making it challenging to reach agreement on policies to put fiscal settings on a more sustainable path. Ageing populations, adaptation to the physical effects of climate change, and increased defence spending in response to geopolitical tensions will continue to add to fiscal pressures over coming years.
Partly reflecting fiscal challenges, ultra-long end bond yields and term premia have risen over 2025 in some countries (Graph 7). The investor base for ultra-long bonds has also been changing. Hedge funds are reportedly holding a larger share. While hedge funds contribute to greater market depth and efficiency in normal times, their use of leverage can amplify shocks. We saw this during the April market turmoil with the unwind of the so-called swap-spread trade that arose in anticipation of an easing of US bank regulation.
Depsite significant uncertainty, risk premia in global markets have been low …
Despite elevated policy uncertainty, market participants have been willing to accept very little compensation for risk. Equity prices have increased strongly in most advanced economies over 2025, and valuations have been high in the United States and Australia, despite some recent declines (Graph 8). Meanwhile, corporate bond spreads have been well below their long-term averages. Overall, market pricing suggests that investors haven’t placed much weight on the possibility of materially adverse outcomes for most of the year, except for a brief period after the April tariff announcements. However, volatility has increased somewhat in recent weeks.
Market optimism around AI, which has been tested a little of late, is one reason risk premia have been compressed. Other factors have been expansionary fiscal settings in some countries and more supportive monetary policy. Confidence also grew as worst-case scenarios around tariffs failed to materialise, along with generally better-than-expected corporate earnings, especially in the tech sector. In Australia, the recent decline in equity prices, which is larger than the decline in US equity prices, has coincided with an upwards revision in expectations for the cash rate and other domestic news.
The question of over-valuation in markets is a key one. With some asset valuations appearing very stretched, a reassessment of the risks or optimism around AI or corporate earnings, could see equity and corporate bond markets shift quickly from currently contributing to easier global financial to something less easy, and possibly even tight or disruptive.
… while gold prices have risen sharply.
Gold prices have been another big story in 2025. US dollar prices have increased by a staggering 54 per cent over the year to date to record highs – the fastest annual increase since 1979 (Graph 9).
What’s driving the increase? One factor is geopolitical tensions and the threat of sanctions. Central banks in some emerging markets have been increasing the share of gold in their reserves portfolio since Russia’s reserves were frozen in 2022 in response to the full-scale invasion of Ukraine. This trend may have further to run, with emerging market central banks still having smaller allocations to gold than many of their advanced economy peers.
Gold is also often considered a hedge during times of global uncertainty. This year, concerns about global fragmentation, US policy risks, including tariffs and perceived threats to Fed independence, and fiscal sustainability in several economies may have added to that appeal. But this explanation is hard to square with still very low risk premia in financial markets and stable long-term inflation expectations.
There are also some clear signs of speculative buying, including significant retail buying via exchange traded funds and queues forming to buy physical gold.
How do global developments affect financial conditions in Australia?
So what does this mean for financial conditions in Australia? First, let me explain exactly what I mean by financial conditions. Financial conditions represent the cost and availability of finance for households and businesses to support economic activity. Conditions are ‘restrictive’ when the cost of finance is high enough to place downwards pressure on aggregate demand and ‘easy’ when the cost of finance is low.
Monetary policy works primarily through its influence on financial conditions. Yet, while important, the RBA’s cash rate is not the only influence on the cost of finance in Australia. Expectations for inflation and the path of central bank policy rates have an important bearing, along with the compensation that investors require for bearing risk.
As Assistant Governor Christopher Kent recently outlined, an assessment of whether conditions are restrictive or tight needs to be benchmarked to something. This is where the neutral interest rate comes in. The neutral rate is the conceptual equilibrium short-term interest rate that keeps growth at potential and inflation at target when no other shocks are hitting the economy. If the cash rate was held steady, but the neutral rate declined, then financial conditions would be tighter than otherwise, all else equal.
Developments in international markets have a significant influence on these determinants of financial conditions in Australia. Key channels of transmission include global influences on the neutral interest rate, spillovers from faster moving risk and term premia that are correlated across countries, and the exchange rate. I’ll now discuss each of these in turn.
Australia’s neutral interest rate is influenced by global and domestic factors.
In small open economies like Australia, the neutral rate is heavily influenced by international developments that affect the balance of saving and investment globally.
In recent decades, estimates of real neutral interest rates have fallen across advanced economies, including Australia (Graph 10). This fall reflected a secular rise in global saving that was unmatched by higher global investment.
A significant body of research has sought to explain why neutral rates fell. Explanations include the integration of high-saving fast-growing emerging markets into the international financial system, slower trend productivity growth, ageing populations, and rising inequality. Demand for safe assets also surged after the global financial crisis because of tighter financial regulation and while the long process of deleveraging dampened investment.
There is less consensus about the trajectory of neutral rates after the pandemic. Different approaches to estimating neutral rates provide different answers, underscoring the significant challenges in estimation. Some estimates have increased. This is the case for the estimates I’ve shown here, which are produced by James Morley from the University of Sydney and Benjamin Wong from Monash University. Estimates based on financial market pricing have increased by a little more. However, other commonly used approaches, based on macroeconomic models, show little to no increase.
The future trajectory of neutral rates is also uncertain. Factors that could push neutral rates higher include growing fiscal deficits, a decline in the demand for safe assets if there is a loosening of post-crisis regulation, or a sustained increase in productivity growth arising from AI. At the same time, many of the factors that depressed neutral rates before the pandemic have not gone away. Despite AI optimism, productivity growth outside the United States has remained weak, and there will be continued population ageing. The effects of AI on inequality are uncertain.
How greater global fragmentation could affect neutral rates is also ambiguous. While it could lower productivity growth, pulling neutral down, it could also restrict capital mobility from high-saving emerging markets, putting upward pressure on neutral rates in advanced economies like Australia.
Bringing this all together leads to the somewhat unsatisfactory conclusion: there is a lot of uncertainty about where neutral rates are and where they are going. What we can perhaps conclude, though, is that they have not fallen since the pandemic and may have even risen.
While the uncertainty may seem discouraging, it is still important to engage with, and in, research and analysis that help us to understand how neutral rates might be changing. Being slow to recognise international developments that might change Australia’s neutral rate is a potential source of error in monetary policy decision-making.
How much influence do international developments have on Australia’s neutral rate? That’s also very uncertain. Morley and Wong estimate that foreign shocks have explained about half of the variation in Australia’s neutral rate since the mid-2000s. They also find that estimates of the US neutral rate on its own is almost entirely sufficient to explain the global influences on neutral rates in Australia and in several other advanced economies.
The finding that the US neutral rate can explain most of the influence of global factors on Australia’s neutral rate is consistent with the United States’ central role in the international financial system. The US dollar accounts for more than half of foreign exchange reserves held by central banks, it is the dominant invoicing currency for international trade, and a reference point for pricing a wide range of financial instruments. Australia’s external assets and liabilities that are denominated in foreign currencies are overwhelmingly denominated in US dollars.
Risk and term premia in Australia move closely with those in other advanced economies.
Next, let me talk to the role of international spillovers into Australian financial conditions from faster moving risk and term premia. These premia are highly correlated across countries. In 2025, measures of equity risk premia, corporate spreads, and term premia in Australia moved closely with those other advanced economies (Graph 11).
The structure of Australia’s financial system means that risk and term premia have less influence on overall financial conditions …
However, the structure of our financial system means that developments in capital markets are less important for overall financial conditions in Australia than in some other economies like the United States.
Our financial system is dominated by banks, which account for around 95 per cent of household credit and two thirds of business debt, which means businesses’ borrowing costs are much more heavily influenced by bank lending rates than by the cost of capital market funding (Graph 12).
Another salient feature of Australia’s financial system is that stock market wealth is mostly held indirectly through superannuation. This is largely inaccessible until retirement, and previous research has found little connection between changes in stock market wealth and household consumption in Australia.
Additionally, as I will expand upon below, the Australian dollar exchange rate tends to appreciate with increases in riskier asset prices, including US share prices. The appreciation of the exchange rate tightens domestic financial conditions, offsetting at least part of the effect of the decline in risk premia on overall financial conditions.
Sovereign bond yields also tend to be correlated across economies. However, international spillovers tend to be largest at the longer end of the yield curve. In Australia, it’s the short end of the yield curve that matters most for financial conditions, with most household and business lending undertaken at variable interest rates and most fixed-rate lending at terms of two years or less. Short-term interest rates in Australia are mostly determined by domestic factors with the cash rate target being the most important influence.
… and the exchange rate acts as a buffer against global shocks.
The exchange rate is one of the most important determinants of Australian financial conditions next to the cash rate. It is a key channel of transmission for monetary policy, and acts as a buffer against global shocks.
The two key long-run determinants of the level of the Australian dollar are terms of trade, which is heavily influenced by commodity prices, and the interest rate differential between Australia and other major advanced economies. Meanwhile, global risk sentiment, which can be proxied by the volatility index measure of option-implied volatility or global equity prices, is important for explaining short-run changes in the Australian dollar, which tends to depreciate when global risk appetite declines.
Now, while the relationships between the Australian dollar and its key determinants hold on average, they don’t necessarily hold at every point in time. At times, the exchange rate can influence financial conditions independently of interest rate differentials and the terms of trade. One way we monitor this is to compare the level of the real exchange rate to estimates of its long-run equilibrium value. Currently, the real trade-weighted exchange rate remains within estimates of its long-run equilibrium, as it has for most of the year (Graph 13).
This year, some have questioned if the relationship between the Australian dollar and global risk sentiment has changed in light of the discussion about the safe-haven qualities of the US dollar. If this were to occur, it could undermine the Australian dollar’s effectiveness as a buffer in ‘risk-off’ events, and against variation in risk premia more generally.
The first observation I would make is that the correlation between the Australian dollar and US equity prices remained close to its historical average through most of the year, and increased during the April volatility, with the Australian dollar initially depreciating sharply alongside falling US equity prices.
I would also observe that Australia is a small open commodity exporting economy that is exposed to both the level and composition of global growth. Nothing that has occurred in the United States changes that. Australia could indeed become relatively more attractive to global investors over time, given our strong institutions and comparably low levels of public debt. This would represent a structural decline in Australia’s country risk premium and so a lower neutral rate. However, even if that occurred, the Australian dollar would still be likely to depreciate during global risk-off events, as it did during the April market turmoil. Of course, if this did not occur for some reason, and the Australian dollar appreciated, the tightening effect of a sharp rise in global risk aversion on domestic financial conditions would be amplified via the exchange rate.
Conclusion
To conclude, 2025 has been an eventful year for international financial markets. It’s also been a year where policy uncertainty and market confidence have coexisted in extraordinary ways. So far, some of the more significant downside scenarios that had been contemplated earlier in the year, including a retrenchment of global trade or a significant market correction, have not materialised. Noting the recent market volatility, this is something we continue to monitor closely.
International financial market developments affect Australian financial conditions through a number of channels, including through global influences on our neutral rate, spillovers from internationally correlated risk and term premia, and the exchange rate.
In 2025, compressed equity risk premia and credit spreads meant that financial conditions in Australia were easier than otherwise. However, the structural features of Australia’s financial system, such as the dominant role of banks, short-term debt contracts, and compulsory superannuation, mean that equity prices and corporate credit spreads have less weight in overall financial conditions. The exchange rate also acts as a buffer against global shocks.
That said, the current global backdrop demands constant attention. As April’s events reminded us, we need to be prepared for potential episodes of volatility and potential market dislocation.