I’ve had my Bill Evans moment. Two things have changed. First, there’s not going to be any macroprudential policy in Australia. House prices are going to go higher, cheered along by the central bank, which is not going to be able to raise rates with the capex cliff and rocketing dollar until it’s too late. That brings me to the corollary; rates aren’t going to go lower this year.
Since the GFC, I’ve held the firm belief that the RBA had changed its spots. Glenn Stevens especially was excellent in the years following the Great Recession as he explained to the nation why it mustn’t leverage up further, why and how the major banks had stuffed up, and how Australia had to fix its external position.
The appointment of Phil Lowe as his deputy was another major milestone. Lowe had written the defining paper in the early 2000s about leaning against the wind in asset bubbles, even as the maestro Alan Greenspan declared the opposite. Replacing the debt-addled Boom Boom Battelino with Lowe seemed a sea-change.
It appeared the RBA had learned the lesson of the GFC, that a private leveraging model of growth was overly risky, especially in a world in which the flow of debt from offshore can cease in an instant.
They hadn’t.
The RBA has learned nothing. Indeed, it seems the bank actually believes its own rhetoric about Australian exceptionalism. That is, that private debt doesn’t matter so long as it’s the result of decisions by mature adults. The RBA doesn’t see any qualitative issues about growth at all, so long as its happening. It is as dedicated as ever to Pitchford thesis thinking and a “do no harm” first principle in central banking, even though both are long past their use-by dates in a world of active peers.
What has changed my mind on this? The flow of material from the RBA yesterday, to put it crudely, dumped a truck load of manure onto my views.
First, Phil Lowe discussed the prospect of China liberalising its currency. He briefly mooted the possibility of a flow on effect to Australian assets, but really, there was little concern there. And the issue that the same process will collapse commodity demand wasn’t even mentioned.
Next up, the Financial Stability Review (FSA) did much the same thing. It mentioned the risks in housing markets, and we in the media dutifully reported it, but really, the message was most noteworthy for its timidity as the FSA also described little risk in markets right now, even as house reach all time high prices on every metric, driven largely by speculation.
Moreover, the FSA contained this little sentence:
“It is important for banks’ risk management that they are vigilant in maintaining prudent lending standards, given that a combination of historically low interest rates and rising housing prices could encourage speculative activity in the housing market and encourage marginal borrowers to increase debt. APRA’s forthcoming Prudential Practice Guide, which will outline its expectations for prudent housing lending practices, should assist banks in this regard.”
That is where the RBA’s and APRA’s discussions of MP policy appear to have taken them: the production of a new guide to bank prudence. If this is true then it must be admired as a charming act of official naivete or condemned as a Kafkaesque act of bureaucratic arse-covering. Either way, macroprudential isn’t coming.
Finally, there was Capt’ Glenn in Hong Kong delivering his anodyne assessment of the Australian rebalancing process. He reiterated the delivery of the APRA help yourself banking guide to prudence, as well as a few wrist-slapping comments about speculation before celebrating the imminent Australian housing construction boom that is completely dependent upon those very speculators. He didn’t even mention the dollar until asked and even then his replies were muttered platitudes.
In short, Captain Glenn flew to Hong Kong to wave a red rag in front of Chinese property capital and forex bulls. The RBA is aiming to produce a singularly epic foreign-funded development boom and does not give a damn about tradable sectors.
So, where does this leave me in my Bill Evans moment of loss of faith in the RBA? Here are my conclusions:
- neither the RBA nor APRA is going to slow house prices or lower the dollar with macroprudential tools (unless the help yourself guide works);
- that removes one of the fail-safes for house prices, which can now run uninhibited. There’s no reason they won’t repeat last year’s double digit growth;
- this is all the more so given the case for rate rises is still weak. The US bond market curve flattening will go on and China will stimulate enough to hit 7% growth (iron ore will still fall) so the dollar can run to 95 cents or higher even without rate rises;
- this will contain inflation, but;
- will hammer the Budget on falling terms of trade and weak nominal growth with little prospect of near term auterity;
- as a result, consumer confidence will remain subdued and there’ll be little uplift in non-mining investment (outside of Capt’ Glenn’s apartments), especially since tradables will freeze anew on the dollar;
- thus the capex cliff will still need to be bridged with the paddle pop sticks and sticky tape of low rates supporting consumption;
- finally, the prospect of rate rises is far enough distant (let’s take Bill Evans’ 18 months as a base case) that we’re just as likely to be overtaken by an external shock before we get there, so I’m not calling the bottom of the cycle.
As for my major investment themes of the past few years, they are unchanged. The RBA’s preferred model of growth is…ahem… unsustainable so taking the opportunity of the higher dollar to load up on external exposures is still the right play. As is avoiding housing with a barge pole. It’s risks are going to go stratospheric. More liquid bank or building materials equities are the way to play that, if you think you’re quick enough.
The RBA’s preparedness to double-down on Australia’s old growth model means we’ll take our highest ever asset prices into the the next external shock, underpinned by unstable Chinese and local investor capital holding ghost city assets in Sydney and Melbourne, and carrying a debilitated external sector, as well as still deteriorating Budget. As a quick as aside, my risk case for the next shock is in the next 18 months on a Chinese credit event.
It’s going to be much worse than it needed to be but in the meantime boom, baby, boom!
