Where is the Aussie bubble tipping point?

Parliament tried to find it yesterday:

Treasury secretary John Fraser declined to indicate what level of household debt would represent a grave threat to the nation’s economy, saying his department’s priority was to monitor the problem.

During more than three hours of Senate estimates testimony Mr Fraser repeatedly warned that the use of debt was “all fine until it ain’t” but refused to clarify what level of borrowing would no longer be consistent with a healthy economy.

…Senator Nick Xenophon, citing a bank industry survey that suggests one in five mortgage holders have less than $1000 in financial reserves, challenged the Treasury chief to nominate a level of debt that was risky for the broader economy.

“I do not have an opinion,” Mr Fraser said when challenged whether the current level of debt was risky.

“I’m not going to get into giving a specific number.”

He said the department, as well as bank regulators, monitor debt levels “in the context of what’s happening with financial conditions, employment and the GDP outlook.

“But there’s no specific trigger point.”

No, there isn’t. But there are tipping points where what was considered solvent suddenly isn’t any longer. Where is Australia’s?

It’s impossible to know when but it is possible to know where to look for it. Funding costs will be the key. Given the RBA has perhaps 75bps of cuts left before it’ll fear going any lower owing to capital outflow (according to the IMF anyway) that gives the banks roughly half of that to pad out margins if private borrowing costs (roughly one third of funding) begin to surge.

To measure these I use the big banks CDS prices. CBA is today 70bps over swap, which is still cheap relative to recent years:

But what also matters is the spread to other jurisdictions and on that basis Australia is starting to show a little unusual stress:

During the GFC, the point at which banks informed the government that they were in danger of being unable to roll over their wholesale debts was when the CDS priced jumped above 150bps. But later, during the later European crisis, CDS prices again rose that high several times without triggering similar stress. That was for several reasons:

  • wholesale funding durations had been lengthened;
  • deposit funding have risen considerably as a proportion of total liabilities;
  • borrowing conditions were very weak on the east coast as high interest rates “made room” for the mining boom which instead did the heavy lifting of funding the external imbalance and the bank’s “funding gap” was temporarily mitigated.

As you can see, finding tipping points for when markets wake in fright to insolvency concerns is contextual as much as it is absolute.

At this stage I can’t do much better than to repeat what Leith and I see transpiring over the next few years in the economy. The headwinds are obviously mounting fast:

  • falling terms of trade;
  • Budget misses and AAA stripped in the next year;
  • stalling and possibly falling house prices and consumption;
  • the dwelling construction boom entering a hard landing;
  • the car industry shuttering;
  • demand destruction thanks to the east coast gas crisis,
  • a business capex draw down spreading from mining into a slow down in services, and
  • a reversal of the agri-boom that supported GDP volumes in 2016.

Then you have to add rocketing political risk as the Coalition’s fortunes crash, it mulls new leaders and immigration cuts, as well as Labor’s negative gearing reforms.

Supports will include more rate cuts, a lower currency, more LNG volume growth and ongoing fiscal deficits. Whether that is enough to keep Australia out of technical recession is a moot question. Either way, unemployment is going to rise and income fall and things get much tougher.

There are obvious candidates for tipping points in there. Ratings downgrades, Budget misses and potentially dissolving guarantees, rate cuts, falling asset prices and rising bad debts.

Is any of it enough to isolate Australia such that the interest rates charged by global markets to the banks become punitive? I don’t think so. The notion that Australia could go bust while the rest of the world is growing OK is still a big stretch.

But it is a context that becomes extremely problematic when global stress rises with the next global shock, whether from Chinese deleveraging, US tightening or some other source in the next year or two.

That’s still my best guess for when the Australian tipping point arrives and rising external interest rates land on a housing slow melt, turning a controlled deflation into an outright financial crisis and asset price crash.

Houses and Holes

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