Chris Joye at Coolabah has an excellent house price forecasting record and he is BEARISH:
The RBA has a long history of getting the Aussie housing market’s reactions to its cash rate changes horribly wrong, which is surprising given how easy the housing cycle is to forecast. Crucially for investors, this interest rate cycle will be heavily influenced by the direction of Aussie house prices, which have never been more inflated after years of cheap money. This will be accentuated by two facts: (1) that hundreds of billions of dollars of cheap fixed-rate loans will transition to much more costly variable rate products in the next 2 years, amplifying the impact of the RBA’s hikes; and (2) that households are generally much more sensitive to interest rate changes than they have ever been before. Specifically, Australia’s household debt-to-income ratio is sitting around 186%, in line with its all-time highs. We project that the RBA will likely be forced–if it acts prudently–to pause its monetary policy tightening process after the first 100-150bps of cash rate hikes (banks will pass on more in the form of even larger mortgage rate increases) as a result of the commencement of a record 15% to 25% decline in Aussie home values. This is something we forecast way back in October last year.
Given the total value of residential real estate in Australia is currently worth $9.9 trillion, we are talking about the RBA inflicting losses on households worth some $1.5 trillion assuming just a 15% draw-down in national home values, which is at the lower-end of our expected range.
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The precise size of the additional out-of-cycle hikes we will see from banks is not known, but their funding costs are soaring, and they have already aggressively repriced 3-year, fixed-rate home loans from 1.98% only 12 months ago to 4.5% today. Non-bank lenders are similarly wearing an overdue repricing in their cost of funding via a steady increase in the credit spreads investors require when they underwrite non-banks by investing in their residential mortgage-backed securities (RMBS).
It is as simple as that.
The majority of Australia’s inflation surge is still coming from offshore. 40% of the Australian economy is tradable, that is exposed to international prices, and it is leading the charge:
Tradables (+2.8% quarter, +6.8% annual)
- Tradable goods component rose (+2.9%) due to Automotive fuel (+11.0%).
- Tradable services component fell (-8.4%) due to International holiday travel and accommodation (-23.1%).
Non-tradables (+1.8% quarter, +4.2% annual)
- Non-tradable goods component rose (+2.9%) due to New dwelling purchase by owner occupiers (+5.7%).
- Non-tradable services component rose (+1.2%) due to Tertiary education(+6.3%).
In seasonally adjusted terms, the tradables component of the All groups CPI rose 2.7% and the non-tradables component rose +1.6%.
Non-tradables have begun to warm up too but note that the definitions are not strict. For instance, the largest non-tradable item, new home prices, is dramatically affected by the price of tradable materials.
Likewise, just about everything is eventually impacted by the rising costs of fuel and transport.
This is important to note because the majority of the inflation surge is coming from the supply side of the global economy as war, plague and deglobalisation run amok. These have been made worse by our own natural disasters.
So, central banks everywhere have become restive and are shifting to tightening. Emerging markets have already been lifting interest rates for over a year and have slowed considerably. Goldman Sachs has a useful index of financial conditions that shows the impact. It is already at recessionary levels for the global economy:
Those with additional headwinds like China are already in recession, their unemployment rates are climbing and inflation is already falling.
The same is now coming to developed markets where the central bank tightening is being led by the US because inflation has taken root much more swiftly and deeply. Its central bank has more work to do to catch up to a runaway cycle:
The danger is that the Fed is so far behind the inflation curve that its drive to catch up over the next few months with jumbo 50bps hikes will tighten financial conditions very fast via a combined bond, stock, and commodity market rout (all of which have begun).
Especially so, when we add that the world’s three largest economies are in shock at once. China is being rocked by its property and OMICRON bust. Europe is being rocked by the war and energy shock. And the US is being rocked by its inflation and interest rate shock.
When considering how the balance of growth, inflation and interest rates will shift in the year ahead, the first observation to make, then, is that global growth is already slowing fast and that the risks are rising that it slows even faster.
In Australia’s case, there are some special circumstances that make this context dangerous. Growth is good right now. But over the next year or so, there is already an embedded rate hiking cycle that is unusually steep before the RBA moves at all.
It is the roll-off of pandemic fixed-rate mortgages from around 2% to variable rates that are already nearly double and projected to go much higher. Nor is it a small number. $500bn of resets are scheduled which is roughly a quarter of Australia’s total mortgage book.
House prices are obviously going to fall. Quite quickly in Sydney and Melbourne. But everywhere before long. We know what that does to demand in Australia’s two largest economies because every time that we’ve seen a house price correction, such as 2001, 2008, 2012, and 2019, demand in NSW and VIC crumbles shortly afterward:
Will there be an offset this time, such as in mining? No. Although Australia’s commodity prices are through the roof, it is all in commodities where no follow-on investment will take place: iron ore, coal and LNG.
In short, the RBA is tightening into a global inflation surge and business cycle that is already very long in the tooth and the risk of policy error is very high.