A terrific piece today from Chris Joye of Coolabah Capital destroying the Lunatic RBA. Republished with permission.
The great Aussie housing crash is accelerating, and it is being driven by the fastest and largest interest rate shock households have faced in modern history. Sydney house prices have plunged almost 5 per cent since their peak only months ago, according to CoreLogic. Home values in Melbourne are not far behind.
The value of residential property in Australia’s two largest capital cities is declining rapidly, exceeding one percentage point per month, which signals double-digit losses over the next year (consistent with this column’s forecasts). There is further evidence that the Brisbane market is rolling over. Adelaide and Perth prices also look to be grinding to a halt.
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If you draw a line through May 2022, when the Reserve Bank of Australia first lifted rates, you can observe a striking structural break in property prices – there was an almost immediate, and dramatic, impact on the value of bricks and mortar. After promising not to raise rates until 2024, Martin Place broke the back of the market with its decision in May and the threat of much more to come. It has not disappointed: in August the RBA will deliver an unprecedented third, back-to-back 50 basis point rate rise (and possibly more).
Yet if you read The Australian Financial Review’s John Kehoe account, or listen to the RBA, you would be forgiven for thinking there is nothing to see here. The RBA has allegedly “slapped down the pessimists who are concerned that its super-sized interest rate rises will crush the housing market and the economy”. Let me assure you, the RBA ain’t slapped down nuthin. And I deliver this message in a Connor McGregor-like lexicon.
According to the RBA’s new deputy governor, Michelle Bullock, “as a whole, households are in a fairly good position”. “The sector as a whole has large liquidity buffers, most households have substantial equity in their housing assets, and lending standards in recent years have been more prudent and have built in larger buffers for interest rate increases.”
Bullock explained that “many borrowers are already making repayments well above what is required” with a lot of the mortgage debt held by wealthy households. The RBA also draws comfort from the fact that “those on very low fixed-rate loans have some time to prepare themselves for higher interest rates”.
I would have rephrased that as the droves of unwitting borrowers who were dudded by the RBA’s public commitment to not increase rates until 2024 (at the earliest) are on notice that their mortgage repayments will more than double in the next year or two, thanks to what will shortly be at least 175 basis points worth of interest rate increases in just three months.
In 2020 and 2021, the RBA relentlessly advised families and businesses to borrow as much as possible on the basis of a commitment not to raise rates for years, only to first renege on that promise in 2022 and then embark on a crazy-aggressive tightening cycle that is destroying the value of their most valuable asset (and much more).
The RBA counters it never “promised” not to raise rates. It certainly “committed” not to increase them and made that a promise by developing the idea of fixing the interest rate on the 2024 government bond at the same 0.1 per cent level as its overnight cash rate. And it spent billions defending the promise—until it suddenly did not in October 2021.
The RBA’s confidence in the strength of the household sector’s ability to withstand interest rate shocks sounds too good to be true. It is, in fact, a classic retroactive rationalisation of a decision it has made to impose super-sized rate increases on the economy on the basis of forecasts that are not worth the paper they are written on. (Even the RBA concedes it cannot forecast its next footstep, which governor Philip Lowe has described as “embarrassing”.)
The RBA always rolls out these “narratives” to justify decisions. And they are always faithfully recycled by the media, which can become beholden to the RBA for informational access.
There was one chart in the deputy governor’s recent speech that really betrayed the vulnerabilities in the RBA’s model. Martin Place crows about how many Australians are ahead on their mortgage repayments and have built up substantial buffers to protect against rate increases.
“The data suggest that over one-third of variable-rate borrowers have already been making average monthly loan payments (including irregular payments to redraw and offset accounts) sufficient to meet [a 3 percentage point increase] in required repayments”, Bullock explained. “In other words, there is limited impact on these borrowers.”
The scarier interpretation of the same chart is that 40 per cent of all borrowers will face a massive increase in their monthly mortgage repayments exceeding 30-40 per cent. You get a similar sense of this fragility in other data.
Westpac recently disclosed that while 29 per cent of all its borrowers are at least one year ahead of their required repayments, a staggering 50 per cent are less than one month ahead. It is a classic bimodal distribution between haves and have-nots.
CBA’s economists show that once you account for repayments of both interest and principal, lifting the RBA’s cash rate to 2.5 per cent would put household debt servicing costs back to around 2008 levels when the cash rate was 7.25 per cent (and official mortgage rates were north of 9 per cent).
This potentially makes a mockery of the RBA’s claim that a 2.5 per cent cash rate would be around the “neutral” level that is neither contractionary nor expansionary for growth.
Since it does not fit the narrative, the RBA is ignoring data showing that consumer confidence in Australia has plummeted to levels last observed during the March 2020 pandemic shock and the Global Financial Crisis. The concern should be that consumer spending, one of the most important sources of growth, is highly correlated with confidence.
Unsurprisingly, CBA’s data does indicate that household spending is slowing despite high inflation which would normally boost the dollar value of spending over time. There are also some early signs that businesses are feeling the pinch, with NAB’s measure of business confidence dropping sharply from recent peaks
Finally, there is CBA’s wage data which, like the official wage price index, suggests labour cost growth remains modest at around 2.5 per cent annually. CBA’s information tracks actual wages paid into 300,000 bank accounts.
The RBA has claimed that for Australia to sustain inflation within its 2-3 per cent target band, it requires wage growth of 3-4 per cent annually. Despite there being no clear evidence that the Aussie economy is meeting this test, the RBA is blindly lifting rates like an inflation nutter.
The discombobulation characterising the RBA is manifest everywhere. There was the error in the RBA’s statement after its last board meeting when the central bank incorrectly alleged it was removing cash rate cuts it had put in place following the pandemic – even though the cash rate was already above its pre-pandemic level of 0.75 per cent.
Today’s 1.35 per cent cash rate is above its June 2019 level (nine months before the pandemic). Yet Bullock maintains the RBA is only unwinding stimulus it had put in place after the pandemic.
“The point is, like every other country, we’re coming off emergency or extraordinarily low interest rates in this country,” Bullock said. “Much, much lower than you would have in a normal, strong economy. And so at least the first task is to try and eliminate some of that monetary stimulus, so that’s what we’re trying to do.”
The issue with this logic is that the RBA’s cash rate is almost double its pre-pandemic level. Following the minimum expected 50 basis point increase in August, the RBA’s new 1.75 per cent cash rate will be the highest it has been since July 2016.
Asked about this topic again during the week, Bullock responded: “We’re at, as I’ve said, extraordinarily low interest rates, and we’ve got to get it up to some sort of concept of what you might call the ‘neutral interest rate’, which means it’s neither expansionary nor contractionary.”
The RBA’s intellectual contradiction was nested in this subsequent statement: “We don’t know where that particularly is, but we know it’s a fair bit higher than where we are.”
How can the RBA not know where the neutral rate is, but in the same breath express confidence that it is a “fair bit higher” than 1.35 per cent?
The RBA seems to have lost sight of the impact of the quantum of debt in the economy. While interest repayments as a share of disposable household incomes might appear low, principal repayments are at their highest levels ever. And borrowers pay both.
You cannot examine one in isolation from the other. We therefore care about total debt servicing costs. Based on CBA’s data, the current cash rate puts total household debt repayments as a share of incomes at levels that are higher than normal. This probably explains why many banks, including CBA and Westpac, believe that the RBA’s “neutral” cash rate could be as low as circa 1.5 per cent.