October 2020: Rate Decision & Analysis
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25% at its October meeting.
After a few months of reporting of reaching the bottom, there is significant momentum to take further steps to drop the cash rate even lower - from 0.25% to say 0.10%.
This is reflected in market interest rates; although short term money doesn't have much further to fall, the 180 day bill rate fell below 0.10% for the first time (see Money Markets below).
From an economic perspective, there is obviously a lot happening with planned further Federal Government stimulus.
There was some surprisingly good news with employment data. The economy created 111,000 new jobs last month, and the unemployment rate fell to 6.8%. This fuels hope that we could bounce out of this period a little more quickly than originally anticipated.
This sentiment was supported by the recent ANZ-Roy Morgan Consumer Confidence Index, which demonstrated improvement - especially from outside Melbourne.
SME Lending Scheme (Second Round)
The Government has announced a revised SME loan guarantee scheme that extends from the 3 year $250,000 offer in March.
The threshold is now extended to $1M, with a term of up to 5 years. The term extension is a critical component, with lenders encouraged to take a longer term view of what the world will look like for businesses post this period.
Whilst this is a good initiative, there are some real challenges in implementing this effectively. Banks obviously have been held accountable at all levels to ensure that they are lending responsibly, so they want to ensure that the traditional approach to credit provision is undertaken.
In our experience, the demand for this product is biased towards businesses that are either in start up phase, have weaker balance sheets or are part of industries heavily exposed to the current environment.
This is especially the case where funding is not backed by traditional collateral. To put that into context, borrowing a $1M over 5 years means a business might paying around $19,000 a month in loan repayments.
What the scheme does do is provide a greater focus on the returns generated from the investment made.
Mixed in with the positive news above, is the arrival of the period where banks will commence discussions about moving customers off their loan deferral arrangements.
According to the Australian Prudential Regulation Authority ("APRA"), there are currently $229 billion of loans on repayment deferrals, which represents 8.5% of $2.7 trillion of total loans,
The expiry of the majority of loan deferrals in September and October will provide us with a better test of what is really happening for households.
With our strong, central intervention, markets remain relatively stable.
The RBA data below is a little complicated, but one of the many insights is the strong nexus between the 90 day bill rate and the cash rate. This is not a surprise, but it is a reminder of how far it has fallen over time.
The proportion of bonds with negative yields has grown to around 25% of the market. That is good news for borrowers but obviously not so good for those relying on a yield from these safer investments.
If we do touch negative interest rates, will there be sustained demand for our longer term bonds in the future? The market will be tested, as we do need to keep funding our deficits.
Meanwhile, the market is processing a chance of a rate cut and our yield curve is looking more normal as below.
|Month||Cash Rate||90 Bill Rate||10 Year Bond|
In the residential market, data from CoreLogic listed below, continues a downward momentum.
The last month has shown the relative resilience of the residential property market. Outside of Melbourne, auction clearance rates and volumes are rising, with Melbourne acting as a lag indicator as things start to open up a little.
It may also be too early for conclusive reflection on the numbers, but there is a strong move to regional properties within proximity to metropolitan areas. We have seen strong demand from our customers alone; they are finding the market very competitive, with listings not lasting very long.
Shifting gears, the outlook for the agricultural property sector is also positive, especially if we continue to see more rainfall.
Commercial property investors remain sidelined due to challenging leasing conditions. There is still competition for quality office assets with reputable tenants and long lease terms.
The currency settled a little this month.
For several months, I have discussed the surprising resilience of the Aussie dollar. The obvious frame of reference is the USD, though increasingly our markets are more diverse.
The diagram from Bloomberg below demonstrates the relative performance of the USD across all markets, with many investors turned off during 2020. The recent bounce is a little surprising given the uncertainty of the election.
Once we are through this and into 2021 we will begin to see the impact on the AUD longer term.
Until next time.
August 2020 (Rate Decision & Analysis)
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25% at its August meeting.
This may be the new normal, especially with the prospect of Australia moving to negative interest rates being an unlikely scenario (see Money Markets below).
From an economic perspective, there are not a lot of highlights. Much of the key data around employment, inflation and other normally consistent data points are skewed materially by current events. Consumer confidence is, not surprisingly, down; however it is not off the cliff as of yet. So whilst retail spending data is down, what they don't show is where the spend is being redirected. In most cases it is sitting in household balance sheets, so there is some buffer for spending in the future.
Reporting season for listed companies is coming, that will give us the data to see the pulse of the economy that many are waiting for.
Exports & China
Despite all the commentary about our deteriorating relationship with China, exports to the country grow from strength to strength, largely on the back of their demand for our commodities. China's share of Australia's export market is fast approaching 50%. We need to look after that basket.
Discussions around tax reform will be the biggest agenda item across 2021 and beyond, and it will be a hot issue for the next federal election. The states in particular will need to work closely with the Federal Government, but a first step is for the states to build some common ground across payroll tax and stamp duties in particular.
There are some early signs that this is happening, with the early noise being a transition from an upfront tax on property to an annuity based system. Though all roads will ultimately lead federally, where there does seem to be some inevitability of a broadening or rate increase to the GST .
Central intervention has been pivotal for money markets and the RBA has committed to markets again, raising another $15 Billion from long term bond sales. In somewhat positive news of market sentiment, these bonds were purchased predominately by overseas investors where there was strong demand. In fact, the sale was nearly four times over-subscribed getting away at under 2.0%.
A reminder if we are to keep sustaining this we do need to keep offering some sort of yield, anything in the slightly positive territory is attractive to those whose opportunity cost is near zero or even negative rates.
In this low yield environment being seemingly here to stay, we are anticipating greater demand for longer term bonds in the future. That is good news for potentially funding deficits.
[table id=13 /]
These numbers make crazy reading but again they have been stable. This is good news for now.
In the residential market, data from CoreLogic listed below, does continue a downward momentum.
Melbourne property market remains the weakest capital city performer since the start of COVID-19. The mood of their market obviously won't be helped by the recently announced Stage 4 lock-down. There is also the market uncertainty for when Government support and bank moratoriums do eventually end.
On the flip side, we are seeing data - some anecdotally - on a good base of transactions, that in our mind tells us that the property market is holding up better than expected.
For more detailed insights, there is some good and deep commentary around, such as from property group Charter Keck Cramer. Their most recent findings take a longer view, especially in providing sound mitigating arguments around stalling migration, population etc. The message in that is that make sure if you want information on property or other assets, you need to deep dive and not grab the news highlights.
In New South Wales, there was mixed feedback on a scheme for eligible first home buyers. This provided stamp duty exemptions on new home purchases to $800,000. Even though this is a temporary measure, there is some fear that increased first home buyer participation may lead to price increases up to the cut off values of the concessions.
This is always the conundrum with property values, we want it to go up but also want it to be affordable for owner occupiers. Whoever can solve that problem is the ultimate mastermind.
The commercial property discussion continues, and again anecdotally things are holding up a little better than we envisaged. This said, looking forward it is obviously weaker. There is a new paradigm around how we work, shop and live, which has implications for both Retail and Office property in particular.
Confidence has also been shaken of late, as a number of recent surveys have shown and this may find its way into both yields and prices.
The currency story is an amazing one.
The diagram from Bloomberg below, shows the strong support for our dollar (albeit against a softer $USD as the Index below demonstrates).
This strength is based on strong commodity prices, including gold which is at record highs. The RBA may in normal circumstances be concerned by this strength, but right now it can be taken as a vote of confidence in the economy and ready buyers for our bonds.
Until next time. Stay well and stay informed.
July 2020 (Rate Decision & Analysis)
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25% at its July meeting.
Whilst the current state of affairs confirms that interest rates will stay low for some time, the markets are moving strongly around them.
Whilst the forecast numbers are very weak and there is fear of that is to come, there was some welcome news that the contraction to our GDP might be a little less than the 5% that was previously predicted. ANZ data also showed a good increase in spending over the last couple of weeks which is at least a barometer of positive sentiment.
Debt & Restructuring
It is a unique time for economic data and our public debt. The most recent forecasts shows us tipping the U.S. styled number of 1 trillion by the mid 2020's. The early thinkers are putting their minds around how all this will be repaid.
One of the solutions in increasing the rate of GST may not be a medium term solution. It is not supported across the states (though with the predicted financial plight of some states it may be a lever they need to look at), whilst another option could be to broaden the base of the GST to include fresh food, health, education etc. This would soak up the current $30 Billion annually that is foregone on exemptions.
Watch this debate unfold over the coming years, as the 2020 handouts will ultimately need to be paid back.
According to RBA/ABS data, unfortunately labour contraction has experienced its sharpest decline since the 1930's. During April for example, total hours worked declined by 9 per cent and more than 600,000 people lost their jobs, with many more underemployed or not working any significant hours. The data below shows the last quarter by industry with some obvious categories being more affected than others.
There is optimism in some quarters that growth can return relatively quickly. Though wage growth may not be on the same trajectory, as business becomes more nimble and less reliant on fixed overhead in the future. This "Gig Economy" as some call it may see a trend for labour to be increasingly sought on a "as needs" basis.
On that theme, many industry leaders are calling on the Government to defer the planned increase to the super guarantee, currently planned to increase to 12% by 2025. Again, "never waste a crisis" and it is a great opportunity for these types of discussions and decisions to take place.
Central intervention has been pivotal to the operation of money markets and the RBA has committed to stay the course with their recent comments. " The (Reserve) Bank is prepared to scale-up its bond purchases again and will do whatever is necessary to ensure bond markets remain functional and to achieve the yield target for 3-year Australian Government Securities. The target will remain in place until progress is being made towards the goals for full employment and inflation".
This statement implies that we will remain where we are for some time. Depending on your standing in the economy, that is either very good or bad news.
[table id=13 /]
This is a set of relatively stable numbers at the moment, ideally with short term rate climbing a little more, which is what is needed in the markets right now.
In the residential market, data from CoreLogic listed below, is slightly more negative this month.
This data confirms that Melbourne property market is the weakest capital city performer since COVID-19. June marked the most material of the recent month of falls with values down over 2% from the previous quarter, albeit after that market was at record highs, as the annual returns shows us. We will start to get some real feedback on the direction of prices, with a significant amount of new listings this winter.
As we discussed last month, the Federal Government suggests that the number of long-term immigrants into Australia could drop by almost 300,000, over the next two years. As the ABS data shows us below, this will impact Melbourne the most materially.
The commercial property discussion remains largely unchanged. The obvious finding is that occupancy rates are at very low levels, begging the question as to whether many larger firms will give up their space on a permanent basis. Sub-leasing may be the new trend during the 2020's as the structure of the workplace as we know it finds its level.
This said, there has been a number of sales activity completed - both large and small - which puts some level of optimism into the long term health of valuations. One to watch as a barometer of both economic health and social trends.
The dollar has continued its strong story.
This support for our dollar is based on the optimism around strong commodity prices and the broad stability of our local economy. Not sure everyone is buoyed by that, but the positive is that currency is in part a reflection of the macro economic outlook of our country.
Until next time.
June 2020 (Rate Decision & Analysis)
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25% at its June meeting.
The RBA has effectively confirmed that interest rates will stay at a record low of 0.25% for a long time to come. Though, that resolve will be become increasingly tested with some economists calling for negative interest rates given the really tough short term economic outlook. An example of more short term pain relief or long term restructure.
Whilst the forecast numbers are very weak, Governor Lowe was a little more upbeat though, “Since we published those numbers, things have tracked...better than the baseline. With the national health outcomes better than earlier feared, it is possible that the economic downturn will not be as severe as earlier thought. Much depends on how quickly confidence can be restored.”
It is a unique time for economic data.
We love hindsight and the ability to say what happened in the previous quarter(s). Right now however, there is more focus on lead indicators (e.g. business confidence, consumer sentiment, job seeker/keeper data applications) and a discussion on what this will all mean over a long term period. When this occurs, so can meaningful debate around policy reform too.
On that score, these lead indicators remain very weak but there are some small signs of optimism. This includes both consumer and business confidence (albeit of very low bases) and a rising local share-market.
It is often said "don't waste a crisis" and one of the few positives of the events of 2020 is data collation. Rather than modelling how businesses and households will perform under financial duress, we have the "perfect" case study presently. The learnings from it can be used to educate future generations in financial management.
Some may need a little more education, with Accenture data indicating that around 40% of people accessing their superannuation (under the temporary access arrangements) did so despite having no reduction in their normal income. Further analysis showed that around two-thirds of the additional spending was for discretionary items. Good for the economy perhaps, not so good for personal balance sheets.
Central intervention has been pivotal to the operation of money markets. The increased supply of Treasury notes, combined with a fall in short-term funding demands by the banks, means they can borrow short-term funds at really low rates. In fact, below the Reserve Bank's target cash rate. From a funding costs perspective, and potentially for borrowers, this is positive news.
For the first time in some time, all interest rates have been relatively stable over the last month.
[table id=13 /]
As I said last month, I really like this yield curve now. Perhaps it is a fools paradise of the traditionalists. However, ongoing confidence in money markets is really important right now.
In the residential market, data from CoreLogic listed below, is not based on a material level of transactions.
As a result, whilst we are seeing most areas in slightly negative territory, the real consideration right now is sentiment.
Without a "normal" level of activity - vendors are really on listing properties if they need to. We are certainly some months away from seeing any impact of those vendors being under duress to sell.
Federal Government suggests that the number of long-term immigrants into Australia could drop by almost 300,000, over the next two years. For the economy, this provides a deprivation of skilled labour, taxpayers and home buyers. The obvious connection of this lack of population growth has been the negative impact on housing construction, rents and ultimately property prices too.
The commercial property discussion is really interesting. There is a raft of different opinions, ranging from those that believe the work from home trend is a permanent one - through to those they caution that people will crave connection again in office spaces that will not be able to hold the same number of people as they could in the past.
The dollar has continued its recovery. This resurgence has seen it wipe out all the Covid-19 losses.
This momentum has been driven by increased optimism around higher commodity prices along with the rebound in equity markets. With the level of fear and uncertainty around, a strong exchange rate is no longer inspirational and being in the 60's against the USD is considered high. This will continue to fuel the interest rate discussion above, especially if our New Zealand neighbours head to negative rates.
Until next time.
May 2020 (Rate Decision & Analysis)
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25%.
With the RBA effectively ruling out the prospect of negative interest rates, this may be a marker that is set for some time. Governor Lowe's position is clear, "the cash rate will not be increased until we are making sustainable progress towards our goals for full employment and inflation".
In terms of economic data, we will see numbers over the first half of 2020 showing the biggest contraction in national output and income that we have witnessed since the 1930's. It is hard to stay resilient in that context, though Governor Lowe's comments were typically upbeat:
"I would ask that we keep in mind that this period will pass, and that a bridge has been built to get us to the other side. With the help of that bridge, we will recover and the economy will grow strongly again."
How long that will take, and the impact it has, we will have to wait and see. Like most economic data, the indicators are hindsight based so we will not know the size of the hole until after it has been dug.
Some forward indicators are worth noting. ANZ and Westpac both released their interim results, showing the quantum of deployed loan repayment deferrals.
Westpac stated that 105,000 mortgage loans (worth $39 billion) and 31,000 business loans (worth $8.2 billion) had been put on hold. ANZ had $36 billion of mortgages and 15% of business customers (worth $7.5 billion) that have deferred.
Whilst this is still continuing, this level is not as severe as some were predicting.
Liquidity & "Quantitative Easing"
By most accounts, the QE programs are building some confidence into our markets.
The Reserve Bank now owns circa $50 billion of Australian Federal and State Government issued debt since it started buying bonds on market. Encouragingly, there have been others that have taken up the slack. For example, Japanese life insurance companies have seen value in our bonds.
Approximately $10 billion worth of NSW Government bonds have been sold, with these investors attracted to the yield (finally at a premium to the U.S.), along with our weak exchange rate. A perfect storm.
With the RBA buying bonds, the yield on the 3 year government bond has been trading very near to the cash rate of 0.25%. So far, this has been successful.
Short term bills are now trading below the 0.25% target rate, while the 10-year rate traded at close to 1.0%.
I like this yield curve at lot better. Especially with the U.S. 10 year benchmark rate now sitting below Australia's. Ongoing confidence in money markets and liquidity (with central support if need be) will be critical in the months ahead.
The data from CoreLogic, listed below, really doesn't tell a story at the moment.
This is especially so with vendors withdrawing properties from sale, not wanting to crystallise any potential losses.
Without a "normal" level of activity in property, attentions turns to anecdotal evidence and the macro economics into the future.
Of most concern to most property watchers, is the potential impact of any sustained fall in the level of net migration. This could be both policy driven and in the short term the impact of the current restrictions.
The commercial property outlook is challenging. It is perhaps obvious to say that declines in both sales volumes and valuations are likely, reflecting the weakness in the rental market. One of the additional concerns is the level of extra supply that was already due in 2020, particularly in Melbourne.
Watch this pace over the coming months.
It has been a roller-coaster ride for the dollar. From a high of US67¢ on February, to US55¢ in mid-March 19, there were fears it could touch below US50c. The past weeks have shown a strong resurgence, nearly wiping out these falls.
This is partly driven by stronger than expected commodity prices (oil aside of course) and the Government's strong fiscal support.
Many commentators do suggest that this is a false dawn, with the inevitably weak economic that will follow globally sending markets backs to their traditional safer havens.
April 2020 (Rate Decision & Analysis)
The Reserve Bank of Australia ("RBA") left the official cash rate at 0.25%. This was broadly the consensus view, despite a few pundits predicting a further 25 basis fall to 0.00%.
With the RBA all but ruling out the prospect of negative interest rates, the attention turns from interest rate settings to following the RBA's role in providing liquidity to our economy.
Increasingly, we are reminded about the RBA's relevance in our economy, and I thought Governor Lowe's comments were typically directional:
"At some point, the virus will be contained and the Australian economy will recover. In the interim, a priority for the Reserve Bank is to support jobs, incomes and businesses, so that when the health crisis recedes, the country is well placed to recover strongly."
The Federal Government has led with significant spending measures, and now we have to fund it.
Liquidity & "Quantitative Easing"
Firstly, some background. In a normal crisis or credit crunch, lending between banks becomes more expensive, leading to an increase in what you what you often hear me talk about - funding costs. During the GFC for example, the RBA was able to slash the official cash rate, which effectively enabled the banks lend to businesses and households more cheaply.
This typical lever of monetary policy - with rates at all time lows - is not available to us right now. This was always the risk with holding such an unconventional monetary policy position.
So what is Quantitative Easing? "QE" is an increase in the money supply by purchasing assets with newly created bank reserves.
These assets are typically longer-term securities from the secondary market. Buying these assets adds money to the economy, with the objective to lower short term interest rates, by bidding up longer term fixed income securities.
What does QE mean for the economy?
In short, we don't really know as we are in uncharted territory in Australia.
Whilst, there are precedents from overseas with less than clear results (see Japan, U.S. for some good reading) it is a good hit of sugar right now.
I have certainly given up on the schoolboy economics, though when the dust settles we need to recognise that QE does bring risks of inflation and downward pressure on our currency.
At some point too - whenever that is - interest rates will have to increase, and the banks will be aware of this when we eventually come out of this current cycle. Make sure you are too.
For most of us, bond and share markets are dreary stuff, though more than ever they will be the litmus test of sentiment.
More Interest Rate cuts to Borrowers?
In the light of the above, unlikely.
There have been a raft of short term measures on interest rates, especially for SME's, make sure you know exactly what your debt strategy is when the dust settles.
In a sense, with QE it is not a "market" anymore, but it is a critical time.
The RBA is determined to keep buying ($30 Billion so far) to keep the yield on the 3 year government bond trading as near to the cash rate of 0.25% as possible.
Initial signs are positive, with the 3 year rate trading around the 0.25% target rate, while the 10-year rate traded at around 0.80%.
In traditional economics, even if manufactured, this is a better-looking yield curve.
We are in unprecedented times, and the impact on property prices may not be known for some time.
For consistency, we have included the data from CoreLogic, where for the March quarter, Sydney and Melbourne continued on strongly.
The current scenario means vendors are generally withdrawing properties from sale. This is a consistent behaviour in a weak property markets, where sellers are not wanting to crystallise losses.
As the table below demonstrates, a lot of the recent losses have been recovered.
The pressure on property values may manifest differently this time around compared with the downturn of 18/19, which was felt mostly strongly in higher value properties. When employment is impacted, expect more impact in the lower to medium sectors of the market.
The commercial property outlook is at an unique period of time. The quality of tenancies is being tested like never before as business grinds to a halt.
The futurists are telling us that working environments will be forever changed; how this plays out for the office market in particular will be fascinating.
Our dollar has dropped again to near 20 year lows this month, which is no shock in times of global uncertainty.
The good news is of course is that it makes our goods and services more attractive in price on a global scale. The bad news is the demand is just not there right now.
March 2020 (Rate Decision & Analysis)
For the second meeting of 2020, the RBA cut the official cash rate to 0.50%.
In the end, this was a surprise to some and it would have been a close call.
The short term outlook for the economy is obviously a challenging one.
Given our growing reliance on China, Australian GDP is likely to be very soft this quarter (potentially in negative territory) thanks to the bushfires and the coronavirus.
The vulnerability of the Australian economy to China is significant. Exports to China make nearly 10% of Australia’s GDP. This is made up of commodities, tourism and education as we discussed last month.
More broadly, there are macro economic impacts with global conditions very soft, and already trending that way when the Coronavirus hit.
The challenge this time (unlike other virus outbreaks such as SARS) is the ability of Governments to intervene. There is no real capacity for use of monetary policy (with interest rates so low globally) and fiscal policy through spending (with deficits so high) so the recovery we have seen when global events like this occur may not be so swift.
Locally, we may see the Government abandon its budgetary targets and introduce some targeted spending measures to stimulate the economy.
More China fears
More negative short term data from the National Bureau of Statistics, showing factory activity in China contracted at the fastest pace ever in February.
China's official Purchasing Managers' Index (PMI) fell to a record low of 35.7 in February from 50.0 in January, which won't mean a lot to many people other than to state this is significantly worse than during the GFC.
It will certainly start to bite some Australian exporters in particular, and they will need to be aware of conditions in the other countries that they export too as well.
Hasten slowly on more Interest Rate cuts
In the light of calls around the world for central banks to intervene, a sobering reminder of the risk of short term economics.
Data from BIS below, shows the growth of US corporate debt to fund spending - ironically a lot of this debt growth has been used to fund share buy-backs and dividends. Whilst that self-confidence is encouraging it does limit the ability of many corporates to absorb financial shocks.
As a comparison, locally in Australia corporate debt is at very similar levels; however it has fallen significantly in recent years, perhaps due to a lack of worthwhile investment projects.
The point of this is complacency. Low interest rates are becoming a generational expectation, so a reminder for business, Government and consumers to consider how they could or would respond if trends eventually reverse.
In the US, some Government bonds dropped to their lowest levels in history this month. This is also being built on the expectation that a strong round of central bank interest rate cuts are imminent.
The same happened on the Australian bond market with all medium term government bonds (up to 5 years) being below the Reserve Bank's cash rate prior to today's announcement.
The 10 year rate has fallen over 50 basis points since the start of the year, further evidence of expectations of a low interest rate environment for a long time to come.
Short term rates fell too, meaning that the yield curve is trying to hold a normal line.
Data from CoreLogic demonstrated the different behaviours when it comes to property and its relative insensitivity to macro economics.
Sydney and Melbourne continued on, the momentum now expanding to other areas including Brisbane, which is growing in its livability reputation.
The growth in Regional areas, by and large has now been outpaced by this capital city growth. Results here though remain diverse between drought affected areas and coastal properties.
As the table below demonstrates, Melbourne has now offically come back from its downturn - clawing back exactly all of the falls of the recent period.
The commercial property outlook is more mixed depending on type and geography. The office market is strong, partly on the back of reduced supply.
Cbus Property's recent approval for a $1 billion office tower in Melbourne’s CBD will be a welcome addition to the market.
Our dollar has dropped to further lows this month, down below US66c as the market priced in our close association with China.
Again, a weaker dollar is a welcomed development for monetary policy makers, with it easing the need to stimulate the economy through lower interest rates. Not that this option remains for the Australian economy.
December 2019 (Rate Decision & Analysis)
For the last meeting of 2019, the RBA left the official cash rate unchanged at 0.75%.
The market is full of mixed signals.
Business conditions for one remain very weak. The latest ABS shows another weak quarter for captial expenditure in particular, which was one of the key areas that the RBA and Federal Government were hoping would lead the charge for growth. Wage growth also remains stagnant, and consumer confidence is low.
On the other hand, the property market has had really strong growth this month (see below) and the Australian Share Market hit highs not seen since the GFC.
With so much conjecture the Christmas break comes at a good time for the RBA, they can wait and see how the market reacts after the recent monetary policy intervention. As a result, we see any further downward movement in rates pushed out deeper into 2020.
The debate about the direction of the economy escalated this month too. With several economic authority cautioning the Government around spending to create stimulus. S&P were ones to state that our precious AAA credit rating could be jeopardised. Whilst they are broadly positive about Australia's prospect for growth, they see that achieving the target surplus should be a priority. Deloitte's published data also broadly echoed this view.
This is the right music for the Federal Government as they sell a cautious approach despite criticism from others.
Growing Household Debt
Of continuing concern to all policy influencers is the growing level of household debt.
The data from ABS/RBA below shows the debt to income ratio of households at record highs. This is despite the record low interest rates, as households struggle with rising essential costs at a time of low wage growth. Compounding this too, is the high asset prices which come partly from the low borrowing costs. To put this in more context, the average size of a mortgage in Australia has increased roughly in line with property prices over the past 20 years. Income growth has not matched this however.
Debt to Income Ratios ("DTI") is a term future generations will become increasingly familiar with, and it is a language of credit assessment being now widely communicated. For a short overview of what it is review here.
Victoria holds the highest DTI at 202%.
Should we be concerned? Yes and No. Household Net Assets positions (from Asset value growth) look stronger than our lower DTI past. The concern remains the exposure to any shocks in the economy, most pointedly to any material changes to the labour market.
This level of household debt is one of the highest in the world.
In that context, DTI can be looked at in conjunction with mortgage arrears rates, which on a national basis are at least not too high by international standards.
The graph below from the RBA does however provide a sobering reminder of the impact of a weak labour market in WA, and the requisite impact on mortgage arrears in that state.
Whilst short term rates were largely unchanged, long term rates dropped over the past month.
With the 10 year rate back to 1.00%, the yield curve flattened again and will be causing concern for the tradional economists.
Lastly, one to leave you with is that around $12 trillion of bonds now have negative yields. By any measure a big number.
Data from CoreLogic showed the highest montly increase since 2003. Sydney and Melbourne were 2.7% and 2.2% higher over the month respectively. Whilst at a national level, values remain around 4% below their peak in 2017, that gap is shortening rapidly.
Whilst Melbourne and Sydney were the star performers the growth was broad as the table below demonstrates.
There were over 3,000 capital city homes taken to auction last week, the largest number since March last year. However, the monthly listings are still well behind last year. It could be that there is a lag between the recent price growth and the willingness of vendors to list.
The demand will likely flow through into 2020 with segements like the First Home Buyers (through the FHLDS scheme) becoming increasingly interested to participate.
Our dollar reversed this month, as the market digested the impact of the interest rate cut in the US last month, sending the AUD back to "normal levels".
This will have been a pleasing development for the RBA, with a lower dollar offsetting any immediate need to take action on the monetary policy front.
We wish you every financial success as we close the 2019 year.
November 2019 (Rate Decision & Analysis)
The RBA defied market expectations and cut the official cash rate to 0.50%.
This result comes as a surprise, on the back of some recent commentary from Governor Lowe that further reductions to the cash rate should not be assumed. He also stated that the economy could be at "a gentle turning point" of recovery and this is consistent with the "over to you" message for both Business or Government to now drive the economy forward.
It is also a chance for the RBA to sit back a little and wait to see how the market reacts after this busy period of monetary policy intervention.
There are some short term results too that may put a pause on the easing button.
The inflation result for the September quarter was above expectation (1.7% annualised) even though still below the RBA target range of 2-3% and employment levels improved slightly. The upward momentum in property prices is also a contributor as we discuss below.
The Government has also been active in trying to create an environment where the banks are able to make credit more readily available. This includes both First Home Buyers (through the FHLDS scheme) and the SME sector (via a welcome clarification of the definition of consumer credit). As Governor Lowe states, "lenders should not be so scared of making a loan that goes bad that they don't provide the credit the economy needs". Some welcome common sense.
In support of the stabilising rate story, long term rates etched up a little over the past month. The market is no longer fully pricing in the prospect of another rate cut in the short term.
With the 10 year rate at least now above 1.00%, the yield curve is a little more encouraging and provides a little more support for the economy in the longer term.
Perhaps of more concern to the RBA this month was the US Fed's decision to drop its central interest rates by 25 points. As the RBA/CommSec graph below demonstrates, we have got ourselves into a bind where we do not want exposure to anything that accelerates demand for our currency.
As we discuss in Currency below, the impact of global interest rates are very significant.
The Residential Property market remains strong, as data from CoreLogic shows, confirming a 1.2% rise in national dwelling values over the month. The October result was the largest month-on-month gain in this index since May 2015, and provides more evidence that the levels at June 2019 may have been the bottom of some markets.
Melbourne, followed by Sydney were the star performers.
One of the reasons for this spike is the First Home Buyer market. They comprised almost 30% of the national market for owner occupier home loans; well above the decade average of 25% according to ABS data.
This can be explained by a combination of factors including housing affordability, lower interest rates, more favourable home loan servicing rules and State Government incentives.
On the commercial property front, Sydney and Melbourne continue to be the best performing markets, though both not growing at the pace of recent years. This said, yields cannot drop too much lower so capital growth will need to come on the back of increased rents.
Our dollar rallied on the back of the interest rate cut in the US. A reminder of Chairman Lowe's comments last month which demonstrates the challenge of managing all competing economic variables.
"If we were to maintain our interest rate in the face of a decline in the global rate, our exchange rate would appreciate, likely moving us away from our goals for inflation and unemployment. So we have to move too and this has been a consideration in our recent thinking on interest rates".
Accordingly, as US interest rates fall, Australian savings accounts become more attractive thus creating a demand for our currency.
This is not sweet music for the modern economy.
October 2019 (Rate Decision & Analysis)
The economic outlook remains pretty dour, with events both worldwide and locally causing concern. The same issues remain - little or no real wage growth, a shrinking residential construction cycle, benign business sentiment, etc.
Last month, we discussed a slowing economy and this is reflected in a GDP trending at 1.4%, well below all targets and expectations.
The discussion is becoming increasingly political; the RBA has not got much more room to move in its efforts to drive the economy, so one expectation is that Government will need to take the lead. Said former Treasurer Peter Costello "Another 25 basis points frankly isn't going to do much to stimulate the economy". The record low interest rates are also driving concern about a rebounding property market, and any resultant growth in household debt.
The Government is still looking to business to take the lead, and to invest. Businesses are saying that despite the low cost of debt or equity, the opportunities to invest are not attractive enough at present.
So, many commentators are screaming for the Government to stimulate the economy through spending.
This is further exacerbated by falling consumer confidence as shown by the ANZ-Roy Morgan Research data below which is really on the back of nothing specifically.
In this context, hard to know who should go first.
Locally, bond rates stabilised this month. With the market pricing in the prospect of a rate cut, short term rates fell a little.
So as a result, although all long term rates are under 1.00%, the yield curve looks a little more normal. However, the money market remains in uncharted space. We are now in a world where Bonds don't actually yield a return. Rather, they are a home for speculators that trade in Bonds ignoring the underlying yield in the hope they can be held and sold for more. At some point that must be fool's gold.
Over the last week, there has also been some real structural concerns for the financial world. Without going in to all the detail, we had a short term liquidity crisis with the U.S. Federal Reserve having to step in and support the market. Watch this space.
The Residential Property market remains strong, though as data from CoreLogic shows, this is off the back of much lower turnover levels.
The momentum is turning slowly as prices improve, but it is relevant to follow through the consequences to the economy of the low level of turnover.
CoreLogic's Tim Lawless makes some timely reminders about what reduced property turnover actually means. "Reduced housing activity implies less spending on retail items such as home furnishings, white goods and appliances. With both values and volumes falling, there has been a hit to state government stamp duty revenues and of course we see real estate industry and finance sector participants receiving less income based on lower rates of sale and lower values."
Timely comments in the context of the soft economic data above.
Our dollar continues to be soft but more stable over the last month. If ever you doubted the strong relationship between interest rates and our currency, Chairman Lowe put that to rest with his comments this month as below:
"If we were to maintain our interest rate in the face of a decline in the global rate, our exchange rate would appreciate, likely moving us away from our goals for inflation and unemployment. So we have to move too and this has been a consideration in our recent thinking on interest rates".
Maintaining a low exchange rate, despite any longer term implications, seems a priority for the "now" economists.
September 2019 (Rate Decision & Analysis)
The RBA left Official Cash rates unchanged at 1.00% at its meeting today.
The theme here is increasingly dour with events both worldwide and locally causing concern. A soft quarter of data means a forecast annual growth rate of only 1.5%, the lowest in ten years. This is coupled with the largest fall in residential construction rates for almost 20 years.
Despite the record low interest rates, businesses here and globally are not confident about capital investment and this is where the increasingly public debate between the RBA and the Federal Government remains hot.
On one hand, the RBA is making clear that monetary policy (with its record low rate settings) has done all it can to drive the economy, and it is saying the Government needs to take the lead and drive investment. "Monetary policy cannot deliver medium-term growth" said Chairman Lowe.
The Government, especially in a fragile global economic environment, is determined to get the budget back to surplus and keep something up its sleeve should things deteriorate further. In turn, they are urging corporate Australia to stop returning excess capital in the form of special dividend and buy-backs, and to invest to get the economy moving. Probably a tough ask in the current environment of uncertainty but like the RBA, they have to put their case on the agenda.
In terms of who is right, depends on your outlook. In the short term, the RBA is concerned about the short and medium term and the ability to create employment, keep inflation within its target, and indirectly manage our exchange rates. The Government, is also concerned about already spiked assets prices and high household debt (i.e. what if we eventually return to a more normal interest rate environment?). More the point, they stress that spending on infrastructure or other stimulus needs to be well considered and yield a return in the long term.
At an altruistic level, we also need a consistent set of principles. We urge households to live within their means and we criticise everyone but ourselves when we don't, so perhaps Government needs to ensure that any stimulus spending is responsible to set the right tone. There is also more to infrastructure investment than money, you also need to be able to mobilise the other resources (e.g. labour) to deliver them efficiently.
The discussion has also remained around given the recent cuts a chance to work, and we are at least seeing that in the property market to a degree. This said, with money markets where they are presently, further cuts are still expected before the end of the year.
A shout out too to our neighbours in New Zealand where they recently cut their cash rates by 0.50% (50 basis points) to 1.00%. The 50 was a shock to the market. I always think staggers of the smaller 25 point cuts are "death by a thousand cuts" and are largely immaterial in the minds of the people you are trying to impact. 50 makes more of a statement and more likely to change behaviour.
We head to unprecedented levels for market interest rates as we show below. Rates took a big dive over the last month prompting the traditional economists to point to a global recession ahead.
All long term rates, including 10 Year Bonds, are all under 1.00% with the yield curve now heavily inverted. The US yield curve officially inverted between 2 and 10 year maturities – i.e. you get less on 10 year yields than a shorter 2 year maturity. Hence the looming recession calls.
Given our place in a global economy, the RBA raised concerns that rates may need to continue to fall. Overseas, the Eurozone is approaching a structural crisis. Take Denmark, where they have had central rates below zero since 2012.
The traditional model of deposit funding being cheaper than market funding has been turned on its head, meaning that banks may need to start charging for deposits or find other ways to make money.
More broadly, the view in Europe is that these interest rate conditions could be with us for years. The German 10 year bond yields have fallen by over 65 basis points this year into negative territory, amid inflationary concerns.
To round out the story, Germany have issued a 0% coupon 30-year bond at a yield of -0.11%. These 30 year yields rates now mean all rates in their market are now in the negative, as the chart from FIIG Securities below demonstrates.
Yield curves around the world are in uncharted space. In fact, with these negative rates the Government is being paid to borrow!
The Residential Property sentiment continues a positive story. Anecdotally, the talk and feedback from Agents is that vendors expectations are meeting market. At this new level, competition is intensifying especially in the Melbourne and Sydney markets.
As the data from CoreLogic below shows us, Sydney and Melbourne clearance rates are leading the way.
So that's the lead data, the lag data is confirming the market improvements as the CoreLogic table shows below:
Our dollar continues to be weak. Australia's reliance on a China economy that is slowing, the US/China trade war, and a combination of other factors continue to drive a lower Australian Dollar.
We talked about the fact that there are always winners and losers from a weaker dollar. We're seeing it at the petrol pump, with our reliance on the U.S. sources driving up price increases. This is flowing into other Australian businesses that rely on imports that contribute to their product offerings.
Until next month.
August 2019 (Rate Decision & Analysis)
The RBA left Official Cash rates unchanged at 1.00% at its meeting today.
Over the course of the last week, markets have been pricing in the prospect of the cut to an even money bet. So the broader RBA comments will be interesting this month given the easing bias currently in vogue.
The discussion has remained around given the recent two cuts a chance to work. In that context it was interesting to see that RBA Governor Lowe forecast that we should "expect an extended period of low interest rates". The focus remains too on the level of inflation, we can expect cuts in the future if inflation targets of 2-3% range are not achieved.
The Inflation Story
With the RBA focus on inflation, recent data from the ABS and analysis by Fidelity International was interesting. Their investigation tracked price movements in sub-categories in the consumer price index ("CPI") since 2000 as shown below:
Official CPI has gone up 57 per cent in this near 20 year period. In the context of the RBA's wants, on an average basis it is within its specified target range.
The challenge is the allocation of prices, or "needs" and wants" as Fidelity International puts it. Most of the need items have increased well above CPI - secondary & tertiary education, healthcare, childcare etc. This has obviously put huge pressure on households, as whilst wage growth has exceeded CPI over the same period, there is a greater concentration of spending to the expensive needs categories.
This in part explains the challenge for our retail economy, with consumers looking to access "wants" cheaper and more efficiently that before. Organisations or Governments that replicate innovation that drives more cost effective "needs" accessibility will be the winners in the long term.
In part too, this explains that despite the record low interest rates, we are seeing mortgage arrears trend up slightly as well.
Last month, we discussed the stakeholders urging the use of cheap debt to fund large infrastructure programs. This month, the ratings agencies bit back and highlighted the need for balance. S&P Global Ratings is one that has urged the Federal Government to maintain its AAA credit rating. Whilst acknowledging that this would be at the expense of injecting fiscal stimulus into the economy.
We talked about the political challenge for Federal Government, with the promise of returning the Budget to surplus. However, with monetary policy easing no longer a material option, an economic shock or two will test that resolve.
A key success factor for Government to get return on investment whilst at the same time giving the stimulus that the economy will need. Spending for the sake of fuelling the economy in the short term (remember the $40 Billion largely wasted on Schools and Recreation post GFC?) won't cut it.
The country needs it best minds on any fiscal stimulus, with infrastructure spending that yields a return at its heart. Hopefully the politics can take a back seat in this regard.
Another new low for market rates as we show below.
The bench-marked and traded 3 Year Swap Rate now well below 1.00%, with the 5 year heading that way too.
What does this all mean? Judging by markets they have taken on Governor Lowe's comments. The current Swap rates indicate that the cash rate will sit not higher than 1.0% over the next 5 years.
This is more evidence that this yield environment is generational. When the next tightening cycle eventually starts again, there will be have to lots of warnings about the "tough old days" of 5 or 6%. Sorry Baby Boomers, your old stories of 17% will be well and truly archived.
Against this weak stories of the economy, the ANZ-Roy Morgan Consumer Confidence Index remains up over its long term average. More evidence again that the interest rate story is also a global one.
The Property sentiment continues its optimistic outlook. Melbourne alone had a great last weekend, with a clearance rate at over 75% albeit from smaller volumes.
As the data from CoreLogic below shows us, Sydney and Melbourne are back in positive territory over the past two months. The 0.2% lift in Brisbane was the first consecutive rise since November last year too and there is some momentum there. Anecdotally, there is interest in a range of property categories as yields in other asset categories continue to dwindle.
Perhaps the lag trend to Regional areas is softening too.
As the CoreLogic data shows further below, it will be interesting to follow values whether the improvement is sustained. In rolling the data forward, an improvement will show up in the 12 month changes which should start to diverge away from the "since peak" results.
After a stable period, Australia's currency fell against the U.S. Dollar. This was in part driven by the RBA's focus on low interest rates. At some point, the fundamentals said that it will have to have a material impact on our dollar.
Right now, we are at levels not seen since the GFC. For those in the market wanting favourable currency conditions, now is your time to shine. Conversely, there are always losers and higher input costs from a weaker dollar might find its way into some price increases.
July 2019 (Rate Decision & Analysis)
For the second month in a row, the RBA dropped official Cash rates by 0.25% to 1.00% at its meeting today.
Markets had been pricing in the strong prospect of the cut to another record low. I am beyond looking at the economic history books for guidance.
The headline discussion has remained around local issues, such as progress in reducing unemployment and progress towards growth and the inflation targets. However, global influences are dominating the thinking right now.
Our exchange rate is one, with the RBA wanting to avoid any upward pressure on our dollar. This is especially challenging with most central banks easing interest rates worldwide. In other words, you don't get the bang for your buck in terms of stimulus when competing with other countries too.
As RBA Governor Dr Lowe reminds us, "we trade with each other, not Mars".
One of the beneficiaries of these low rates is Government, with States going into debt to fund large infrastructure programs. The RBA in fact has been very vocal in the opportunity to take advantage of cheap rates to fund infrastructure projects, adding that monetary policy is losing its bite (no surprises there).
This may however be a political challenge for Federal Government, balance cheap money with the promise of returning the Budget to surplus.
Again, we will see how banks react. There has been a flurry of activity with lenders after last month, and some have already played their hand with balancing out their fixed and variable interest rate offers.
These low cash rates put pressure on bank margins, they will need to balance the political pressure and their need to protect profits which have been sliding over the last year.
If I said last month rates were low it certainly wasn't the bottom as we show below.
In an era of surprises, we even saw the commonly bench-marked and traded 3 Year Swap Rate below 1.00%.
Australia is obviously not alone in terms of money markets with bond yields collapsing across all established markets. This of course has many economists concerned about what lies ahead, especially with growth slowing in China.
There are however more signs that this yield environment is approaching generational proportions. Take a strong economy such as Austria. Following demand from a few years ago, they have just released a 100 year bond with a fixed coupon of 1.10%! For many investors, this at least provides certainty especially if you compare this to Germany's -0.25% return on a 10 year bond.
In terms of spending on infrastructure, State Governments in Australia could look to China. The graph below (Courtesy RBA) shows that their local government bond market has grown rapidly, overtaking the US in recent years. It is now the largest municipal bond market in the world.
The central Government is still strongly supporting this program, though there are signs that the infrastructure pipeline could be slowing down. This is what builds uncertainty to China's partners around the world.
Australia's currency is still soft against the U.S. Dollar, but stabilising. It is down just over 5% over the last year. This was probably less than I had expected, especially given the historic position of our interest rates - well below the U.S.
Strong commodity prices and our narrow current account deficit have offset the imbalance in interest rates, and with the Fed's next move likely to be down, this could put some upward momentum into our dollar. As always with currency positioning, this suits some and not others.
The Property sentiment continues its optimistic outlook.
Clearance rates are not always the most relative statistic, though they are a barometer of activity and the CoreLogic data continues to show an improvement.
Again, anecdotally, we have seen more demand and stronger results in many instances for vendors.
The Melbourne and Sydney markets in particular are showing signs of life.
June 2019 (Rate Decision & Analysis)
For the first time since August 2016, The RBA dropped official interest rates by 0.25% at its meeting today.
In the end this was not a surprise to many, with the market pricing in the strong prospect of the a 0.25% (25 basis points) cut to the official cash rate.
The discussion has been centred around muted growth and business investment, household consumption and inflation numbers. More broadly, as we outline in Money Markets below, the official cash rate is now more relevant as market interest rates have already fallen down around them in anticipation.
This was against a post election burst in positive energy reflected in a stronger share market.
Now the fun begins as we see how banks will react. Mortgage holders may have to temper their expectations, as we do not expect that lenders (ones that are competitive currently at least) to pass on the full amount of the cut.
Alternatively, many lenders have led with fixed interest rate offers as the lever for sharper rates. In a low interest rate environment, this may be a trend that continues in the medium term much like overseas.
The yield curve in Australia was technically inverted as the table shows. However, we have had to create history to drive that - with the 180 Day Market Rate at it lowest ever point in recorded history.
It did get me looking at the history books which took me to a time in 1974 when the short term was actually over 21%.
The current rates are almost unimaginable if you, like me, studied any traditional economic theory. If a futurist had told me we would have rates at this level in 2019, I would have imagined an unprecedented level of economic carnage.
The risk to our economy moving forward is that we do not have the lever of monetary policy. This was a fear always shared by the traditional economists but there has been a chorus of support from many business leaders too.
We are at an interesting in the financial cycle. The graph below (Courtesy ANZ Research) shows the gap between the Cash Rate and the 10 Year Bond Rate over the last 30 years. The 10 Year Bond is now at the lowest level in history. Traditionally, this would suggest that the outlook for the economy is negative.
There is certainly precedent for this as we look back in history, though I am not convinced this time. The paradigm for interest rate policy is different worldwide, with central banks much more proactive in using monetary policy as a tool to manage economic health.
We must also consider the debt bubble fear, with many countries feeling that they cannot increase interest rates at present regardless of the other economic variables.
A big reason that gives the RBA to lead such low rates is the relative health of the Australian dollar. The dollar's strength is supported by the robust commodity prices and our rapidly falling current account deficit. This narrow deficit means that we are less exposed to the traditional currency weakness that is associated with low interest rates.
In other words, we are almost able to fund ourselves.
Property is out of the political spotlight (amazing how fast we move on) and anecdotally the sentiment is up. The last month's worth of data below obviously include pre-election figures - so the following month will provide some insights.
A guide of post election activity is via the latest auction clearance rates. The last week saw Melbourne continue to be above 60%, whilst Sydney clearance rates broke the 60% mark for the first time in a long time.
The updated Corelogic data shows a slowing correction.
With some early signs of confidence returning - it is timely to look at more Corelogic data to put a marker of longer term trends.
Dwelling values have fallen by 8.2% from their peak, and the stark results in Perth, Darwin and parts of Regional Queensland are important reminders that property can be volatile.
We have commented previously about the lag rise in many Regional areas, but it is also worth reflecting that over a five (5) year period they haven't out-performed capital cities.
The next three months of so of data across the entire economy will be worth a look.