More than a whiff of panic is emanating from RBA and APRA

It was always going to end this way. They held on too long and now they’ll have to go all in. Via Damien Boey at Credit Suisse:

APRA has just announced that it will no longer mandate the banks to use of a minimum interest rate of 7% for loan serviceability assessments. Instead, they will be able to set their own threshold for rates, and effectively choose their own adventure.

A change in loan serviceability test was flagged in the press a few weeks ago. Apparently, senior officials of financial institutions had supported the amendments, although anecdotally, we understand that the change in rates threshold may not relax all the binding constraints on mortgage lending activity, given the many moving parts involved.

As far as we are concerned, credit easing was always going to happen. In 4Q, there was a massive undershooting in home sales, largely because credit conditions had tightened so significantly during the Royal Commission. Also, we have seen loan approvals fall substantially relative to the stock of credit, reflecting past tightening of credit conditions. Our proprietary credit conditions index, which takes into account banks’ willingness to lend on interest-only terms, banks’ willingness to lend to high loan-to-value ratio customers, and credit spreads as a proxy for the tightness of commercial lending standards, has been pointing lower for some time. It has historically been a very powerful leading indicator of loan approvals, and recently, it appears that the historical relationship has re-asserted itself, after a brief “de-coupling”.

If APRA is indeed at the beginning of its credit easing program, and credit spreads remain narrow (or even tighten further), the risk is that the credit conditions index will rise, foreshadowing a 2020 recovery in loan approvals.

None of this is sustainable in the long term. Relaxing lending standards is a poor way of dealing with de-leveraging pressures and avoiding the zero interest rate trap. Fiscal stimulus is the better way. But fiscal stimulus is not as likely under and LNP government, and so monetary policy is bearing the burden of adjustment.

Bonds have sold modestly on the APRA announcement. This is understandable given that duration risk appetite is so overbought. But when we are talking about 10-year bonds, we are talking about the longer-term outlook. What the RBA and APRA are doing will merely accentuate the python trap of low interest rates by exacerbating the binding constrain on rates – household leverage. Shorter-term, we note that even after accounting for current financial conditions, and some easing, it is unlikely that real GDP growth will recover to an above-trend pace. Indeed, we still have question marks about how effective easing will be. If growth does not head north of 2.75% any time soon, the risk is that inflation will drift further below the RBA’s target band.

All of this means lower rates for longer.

Yep. Two rate cuts in H2 as unemployment rises and house prices take time to turn. If you recall the 2010/12 correction it took nearly two years and a flood of Chinese dough to get the property market moving again. It’s in an even deeper slumber now.

Worse, because of the panicked APRA cuts, the RBA may be forced to wait to gauge the effects, meaning it won’t cut a third and fourth time as quickly as otherwise, and will again hold the Australian dollar higher than it needs to be to get the tradable economy moving.

This is why we should have exhausted rate cuts first, then tinker with lending standards. For obvious reasons this would have crashed the AUD and allowed for fine tuning of credit along the way. The RBA is the hammer, after all, APRA is the only the screw.

I still think there’ll be a bottoming in house prices and lift into 2020 but it isn’t going to shoot the lights out and, depending on how fast Vale recovers and the trade war progresses, it may get hit by another income shock in short order.

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