Is the heat coming off the housing market?
The RBA expects to hold interest rates steady until at least 2024 but acknowledges the need to curtail the housing boom and has signalled the potential introduction of macroprudential measures.
Will we see heat come out of the red-hot domestic housing market?
In this month's episode of The Rate Debate, I discuss this week's RBA announcement with my colleague Chris Rands, co-head of Australian fixed income at Yarra Capital Management.
The announcement itself might have been short and light on content but there are signs the RBA would like to slow the housing market a little.
Central banks in other countries are talking more about inflation pressures and the prospect of raising rates but the RBA has shown great reluctance to do anything that might harm the golden goose of the Australian economy: housing.
As Chris says, "Certainly from the past kind of experience over the past five years, it does tell us that it's a little bit of be careful what you wish for because once housing slows, it generally slows down a lot of the consumption figures in the economy as well."
Chris and I also discuss:
- Why we're not done with COVID just yet and what looks like inflation could actually be issues in supply chains. Semiconductors for cars are a good example.
- What the next black swan is likely to be as the pandemic comes under control.
- How the misfortunes of Chinese property developers raise questions about effects on the broader economy.
- What might happen if macroprudential controls are placed on the Australian housing market, especially as the Federal Government withdraws economic stimulus.
- Why the RBA is likely to defer any significant interest rate action until 2024.
For more detail, listen to the full podcast below.
Darren: Hello, and welcome to the 21st episode of The Rate Debate. I'm Darren Langer and joining me is my co-portfolio manager, Chris Rands.
Chris: Hello everyone.
Darren: Well, it's the first Tuesday of October and that means the RBA has just met. And unfortunately, not a lot to say really. It was probably one of the most nonchalant RBA statements of some time: very short and pretty much sticking to the script of what they've said for the last couple of months. I guess Chris, the only real thing of note is that they probably made a little bit more of a throwaway to macroprudential on housing and I guess a little bit of a wave to the banks about responsible lending. So I guess you can read that perhaps they're starting to worry a little bit more about how fast housing is running. What did you think?
Chris: Yeah, I think given the news that we've seen obviously from other agencies kind of talking about macroprudential coming soon, that certainly is on the radar. So definitely it does look like they're beginning to at least be a little bit worried that they need to slow it down slightly. When I look at the statement though, I think it was really just a continuation of what they told us last month. They're going to continue QE until February, and until then we don't really need to tell you anything more. That's what it kind of looked like to me.
Darren: Yeah. It's, "Come back in February. Don't bother us in the meantime," I think. I think the RBA is pretty happy with their view for the next couple of months. That probably can't be said for some of the central banks offshore. We've certainly seen the Fed starting to talk more and more about inflation pressures and the need to start tightening policy. They're sort of talking mid-2022. There's a good chance tomorrow that we'll see the RBNZ pull the trigger for their first rate hike in a very long time. We've seen similar messaging coming out of the Bank of Canada, the Bank of England also starting to get a little bit hawkish and we laugh a little bit about it but even the ECB who are in no chance of lifting rates anytime soon have probably been as hawkish as we've heard them for some time. What are your thoughts in terms of will that change the RBAs trajectory, or do you think the RBA will be relatively happy to stick to the script?
Chris: I think at the moment they're still certainly sticking to the script. I mean, you look in the statement and they're still saying that the conditions for a rate increase won't be here until 2024. So they've said that basically in every meeting now for the past 12 to 18 months. And so for them it does look like that they are going to be sticking to that. As you said though, BOE, the Federal Reserve, the RBNZ, they're all seem to be getting ready to hike, and kind of my personal feeling of maybe last month's meeting where they decided to continue with the taper, but delay the timing, so allow it to run a bit longer, whether that was kind of their nod to trying to follow everyone else in that. We've reduced the bond purchase size as well, so we're kind of on a similar timeline, but our cash rates hikes are going to be further out, but we're going to try and do our best with QE in the meantime.
Darren: It's certainly interesting that they're as relaxed as what they are given how other central banks are starting to behave. There seems to be this thing that we've talked about before that the first signs of any inflation in an economy for 10 or more years, and it's time to stamp it out before it really gets a hold despite all their protestations that they would let it run a little bit, given that in the past perhaps they've killed the growth off a little bit too soon, I guess it still remains to be seen. I mean, most of it is just talk at this stage, RBNZ probably being one of the few that will definitely tighten rates tomorrow. But even then it's likely only to be 25 basis points. I guess we might get some idea from their economy, although being such a small economy it probably doesn't give you a really good guide to what could happen here. The Fed's probably the one to keep an eye on.
Chris: Yeah, I think kind of when you look at what a lot of these central banks are talking about, a lot of them do say that they think the inflation's going to be temporary, but we're now kind of getting to the point where it's been six months and there's no sign of kind of it abating. The thing that sits in the back of my mind with all of this is they're kind of all getting ready to start hiking rates even as we're kind of in the middle of this COVID crisis still. So, it's a little bit kind of questionable I think of how hard you want to go early. But the other thing that kind of flows on from that is if you believe that the inflation is temporary because of the situation that we're in, you lock down economies, you disrupt supply chains and that's going to cause inflation.
Well, we're not yet out of the COVID crisis to the point where you can expect that to normalise. So it's I think questionable to overreact early to the inflation because you're still not certain whether it's a COVID-related problem or whether it is actually the inflation that they've trying to generate for the past 10 years.
So I think that's probably going to cause them to be slower than perhaps the market expects, but they're obviously looking at the current levels and saying, "This is starting to become a problem."
Darren: Yeah. I mean, it's something we were talking about earlier today. A lot of what we're seeing inflation-wise is really supply issues. I mean, none of these things were there pre-COVID. We had no signs of inflation at all pre-COVID, quite the opposite. Suddenly we've gone into this crisis. We've seen central banks pump huge amounts of money into the economy. We've got supply disruptions, various other things that are leading to price increases. There's absolutely no doubt about that, but we don't know really whether these imbalances are a permanent feature of the landscape going forward. As I said, pre-COVID, we would have sort of laughed this off to some extent. And we've seen in the past areas where one particular sector's run really hard for a little while and people are worried about inflation, but it's been a single sector, whether it be food, or transport, it's never really been a problem globally and sustainably.
But now we're in the situation where there are probably a lot more than we would have expected, but things to me that don't make a lot of sense is that we see semiconductors in particular in the car industry are causing backlogs to getting new cars out the door. But we're not really seeing massive problems in some of the other electronics-related industries. We're seeing petrol supply issues in places like the UK, but there's no shortage of oil or refining capability that I'm aware of. So it seems a little bit strange that some of these things are happening, and we are starting to see wage claims come through in places like Germany and things like that despite having still pretty average employment situations. So again, it's hard to know whether those are industry specific, or whether they are leading to a more systemic problem that the central banks will need to deal with. What are your thoughts there, Chris?
Chris: It's kind of very hard, I think, to really gauge just how much of this is going to be problematic into the future. And I think that is why when you read a lot of the central bank statements, they are saying, "We do expect this to be temporary." But even though they're saying that it's starting to pick up. The kind of thing that I think is always the most important indicator for inflation is oil. And as you mentioned, there are some shortages turning up in certain economies and that is pushing prices higher, which generally brings inflation with it. So over the next six months as well, now that oil is setting new highs, it's perfectly likely that we probably will see inflation pick up over that period.
When you look at kind of some of the other issues like the semiconductor issue, you kind of need to dig a little bit more to figure out just what's going on there.
And from what I've seen, the best that I can figure out is that basically in 2020 when COVID hit, there was an assumption from the semiconductor producers that demand would fall. And so they actually reduced their supply through that period, but what actually happened because of the stimulus was that demand picked up. And so because of that, you didn't have enough supply, you've got much more demand than you expected, and they're struggling to catch back up to where they were. The reason that I look at that and say eventually it's going to be temporary, is that once you bring the new supply online, then you'll probably be meeting that demand and prices can level off. Again, when you kind of fall back to thinking about the central banks, do I want to tighten rates too hard here on an issue that could potentially resolve itself in 12 months time? That's kind of the hard part of where they sit at the moment.
Darren: Yeah, there's certainly, I think we talked about this last episode, a lot of certainty around a very uncertain outcome. I'm with you. It's really difficult to sort of sit back with any confidence and say, "This is what the economy or the world will look like in 12 months time." We thought that a year ago and 2022 ended up being pretty much a disaster in terms of growth in most places around the world. We're still dealing with the COVID situation. There are some good signs, vaccination rates are up, but we know that the economy is not going to return perfectly to normal, even if we do get to that point where we're at 80% vaccinated, and we still haven't allowed for any left field events. And they're the things that keep you and I awake at night is we've seen COVID, okay, the worst of that may be out of the way, but what's the next thing? They're very hard to predict, those kinds of things.
Chris: Yeah. And obviously what's going on in China at the moment kind of looks similar to that well, who knows what's lurking out there at the moment? Certainly something that I've seen over the past 10 years is that every time a central bank or a government kind of tries to either tighten QE, reduce fiscal spending, we generally start to see some credit sectors start to blow up. So at the moment it seems to be turning up in China, but you think back five years, it was in Europe. And you think back before that, it's Greece. And so every time they do try and tighten it, it does look like there's a part of the global economy that is just a bit too leveraged to rates.
Darren: Yeah. I think we've tended to avoid talking too much about the Chinese property developers, because plenty of other people who know a lot more about that sector than we do, but you're right, in general, that's what derails the economy is some kind of credit crisis that cuts off supply to industries that have been far too used to easy money. You pull the rug out from underneath them and it starts a chain reaction through the economy. The chain reaction often depends on how big that industry is relative to everything else, and often how deep the government's pockets are. From everything that I can see the Chinese government has sufficient liquidity and sufficient, I guess, reserves to cover the size of the problem that we can see.
But as I said, you don't know whether this is the tip of the iceberg or whether it's the entire problem and that's still to play out. We also don't know what the interlinkages are between the internal Chinese economy and the external market. That's always a much harder thing to see. So we're guessing as much as anybody, but I agree, if there's going to be a problem somewhere, it'll be that one of those credit events that happens more from a liquidity perspective than necessarily a really obvious bad business practice.
Chris: Yeah. And the thing that kind of I have found interesting, I guess, over the past kind of three or so months is that about six months ago, a lot of the credit indicators in China started turning over. So you can kind of check some of these out, like the credit impulse, and monetary conditions, or M2 growth, those types of things. A lot of those turned over in February. And the thing that kind of I have been thinking over the past three months is it's quite interesting that the RBA hasn't really said too much about what looks to be tighter credit conditions in China. So, that's more so just an observation of me thinking, "Huh, that's interesting." But it does kind of start to look like now we'll probably get a bit more of the minutes and those types of things dedicated to talking about whether or not it's going to be a big issue or whether or not we're just going to skate through it.
Darren: Sure. And I guess that's a bit of a segue into what we were sort of going to discuss about why macroprudential might end up being a reasonable big problem for the Australian economy. For a similar reason, the Australian housing market is a big part of our economy. It drives a lot of spending. It employs a lot of people. So any really sharp changes to policy there can have a fairly significant impact on the total economy because it is such a big part of the market. What we've seen in the past is macroprudential will matter, how quickly they do it, and how hard and aggressive they go at it will matter. But what are your sort of thoughts in terms of what might happen from here if we do start to see APRA and the RBA bring in some kind of macroprudential controls on lending?
Chris: It's going to depend a lot on what they do. So if you kind of look back over the past two times they've done this, they were very focused on investor lending. And it sounds like from the news that that's what they're going to be focusing on again. At the moment it's actually owner occupiers who are taking the majority of the finance out so perhaps it doesn't quite hit as hard as in 2015 and 2017, but even then, it's certainly going to slow the market down. If you just kind of crudely draw on to a chart of house prices the prior timing of macroprudential, what we saw was they did their first basic investor restrictions in June of 2015, and then the market peaked in November of 2015. And then the market actually picked up about six months after that because the RBA cut rates.
Then the macroprudential was done in 2017 and the market peaked again in late 2017 and it didn't pick up again until the RBA cut rates in 2019.
So basically what I've seen from macroprudential is that about six months after they do it, you see house prices peak, and then about 12 months after that you see the RBA cut again to bring the economy back to life through housing.
So, maybe this time you don't have an RBA who needs to restimulate it, but certainly from the past kind of experience over the past five years, it does tell us that it's a little bit of be careful what you wish for because once housing slows, it generally slows down a lot of the consumption figures in the economy as well.
Darren: We talk about as housing being the golden goose for the Australian economy and killing it's always a pretty dangerous thing. It's going to be really tricky for the regulators to get out of this. I mean, I guess the one thing we have at the moment that's probably a little bit different to the last episode is we've got a fair amount of fiscal stimulus going on in the economy, but you've also got a government who is hell-bent on withdrawing some of that stimulus fairly quickly. They have got a reasonable amount of pickup in terms of extra revenue which they weren't expecting. So maybe they won't be as aggressive on that side of things on balance, but it's really hard to know for sure.
And it's getting to a tricky point. If you're right about the six months after sort of macropru starting to kick in, that's probably getting us towards the end of 2022, the beginning of 2023. You've got some forecasters out there saying that the RBA will be forced to start tightening rates in some time in 2023. If they go too hard on macropru, it could end up being in a situation where they can't tighten at all. We don't know that, but that's the really big risk. And certainly by 2024, if we're starting to see the economy slow materially, they may not be able to tighten at all. So there's lots of very difficult decisions I guess to be made, and long-term impacts from some of those decisions that we can't possibly know what will be the outcome, I guess, based on what we think might happen. It's very hard to see again still how the RBA can be so certain about needing to tighten in 2024.
Chris: Yeah, I think just flowing on from that it's why the 2024 timeline as well makes so much sense, certainly in my head, and why the RBA has probably been reiterating it so much is that if you do get a Q1 macroprudential then as you say, you get house prices slowing in 2022 and potentially moving slightly lower in 2023. And the RBA has not hiked rates when house prices were falling over the past 15 years. They just haven't done it. So for you to expect that there's a bit of weakness in housing and then for them to hike rates on top of it, that just seems a little bit implausible. So you probably need to wait for 2023 to make sure that everything is fine, and that sets you up for 2024. So in terms of kind of implementing these policies in kind of how I think about things in the timelines that housing is run on, certainly it does make 2024 look much more likely than 2023 as the time that the RBA could go if they needed to.
Darren: Sure. Either way, I wouldn't be wanting to be the governor who has to announce a tightening of monetary policy at the time house prices have already fallen 5 to 10%. I don't think that would be a very popular decision, even if it might be the right one at the time, but I guess we'll see.
That's it for this month. Tune in next month when we deliver our thoughts on the RBA's November rate decision and provide an update on what's been happening in markets. And remember, if you ever want to suggest topics or discuss anything further with Chris or myself, please contact us at firstname.lastname@example.org. Until then, stay safe.
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Darren is highly regarded in the fixed income industry and is regularly featured in the press. He is also co-host of the popular Australian podcast series The Rate Debate. He has more than 30 years’ experience in fixed income markets and 25 years...