Greenspan Warns Of Rates Rises

Alan Greenspan, the former Fed Chair, speaking on Wednesday on Bloomberg Television said “there are two bubbles: We have a stock market bubble, and we have a bond market bubble”.

This at a time when US stock indexes remain near record highs and as the yields on government notes and bonds hover not far from historic lows.

As the Fed continues to tighten monetary policy, interest rates are expected to move up in coming years.

At the end of the day, the bond market bubble will eventually be the critical issue, but for the short term it’s not too bad

But we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, as you know, on the whole structure of the economy.

What’s behind the bubble? Well the fact, that, essentially, we’re beginning to run an ever-larger government deficit.

Greenspan said. As a share of GDP, “debt has been rising very significantly” and “we’re just not paying enough attention to that.”

“Irrational exuberance” is back!

ANZ responds to fiduciary duty breach claims

From Investor Daily.

Last week, ASIC issued a report confirming in-house product bias within institutionally-aligned licensees between 2015 and 2017, finding that 68 per cent of all client funds across these businesses had been invested in products owned and operated by related entities.

A review of sample files where advice to switch products to an in-house product was provided also found that as many as 75 per cent did not meet the FOFA fiduciary duty in ASIC’s opinion.

Responding to questions from InvestorDaily, a spokesperson for ANZ said its internal review of in-house versus external product distribution had yielded different results to those of the regulator, but noted the bank was unaware how ASIC gauged the numbers.

“Our assessment of the split between ANZ Financial Planning customers’ investments in ANZ products and those in external products is closer to 47/53 respectively, but we do not know what methodology ASIC have used,” the spokesperson said.

The bank said it also permits advisers to apply to recommend products not included on their APLs, and last year received 1,200 of these requests – an “overwhelming majority” of which the spokesperson said were approved.

The spokesperson added that the bank “will continue to work with ASIC and all the other regulators to help them with the important work they do to keep our industry secure and accountable”.

ANZ’s comments follow the release of an internal letter written by the bank’s chief executive, Shayne Elliott, addressing the royal commission into banking, superannuation and financial services.

In the letter, Mr Elliott said seeing all the bank’s instances of misconduct over the last decade laid out in a single document was “confronting”.

“It’s completely unacceptable that we have caused some of our customers financial harm and emotional stress. I’m ultimately accountable for this and once again apologise,” Mr Elliott said.

“Of course, it would be easy to lay the blame on a few bad apples or to say that these are largely historical technical glitches resulting from large complex IT systems. That would be wrong.”

Spokespeople for AMP and Westpac both referred InvestorDaily to the FSC, which has also challenged the investigative approach used by the regulator.

Dwelling Approvals Fall Again

The ABS released the latest dwelling approvals to December 2017.

The number of dwellings approved fell 1.7 per cent in December 2017, in trend terms, and has fallen for three months.

Approvals for private sector houses have remained stable, with just under 10,000 houses approved in December 2017, but the fall was in apartments.

In trend terms, approvals for private sector houses fell 0.2 per cent in December. Private sector house approvals fell in South Australia (1.5 per cent), Western Australia (0.9 per cent) and New South Wales (0.2 per cent) but rose in Queensland (0.4 per cent). Private house approvals were flat in Victoria. But it is the trends in unit approvals which show the most significant variations.

NSW is leading the way down from a high in May 2016.

QLD continues to slow, from a peak in November 2015.

WA is moving up, just a little, from a low in May 2017.

VIC is bucking the trend, with a significant rise since May 2017, but we wonder for how long, as supply is already taking the heat out of new unit sales.

The value of total building approved fell 0.3 per cent in December, in trend terms, after rising for 11 months. The value of residential building fell 0.2 per cent while non-residential building fell 0.4 per cent.

Sell Overpriced Properties to Unsuspecting Clients

From The ABC’s Michael Janda.

Real estate sales companies are using big commissions to tempt mortgage brokers, financial planners and accountants to sell overpriced properties to unsuspecting clients. Here is the segment from ABC The Business.

 

It is a business model that has been operating for years, but is raising more concern now that many of Australia’s largest property markets are heading for a potential apartment glut.

Developers generally contract out sales to these companies when they are having difficulty shifting their stock, such as when there is an oversupply of new apartments or houses in the area.

Real estate agents say developers use these sales companies, which often market themselves as property investment firms, because they can achieve higher-than-market prices.

One reason the properties are so far above market prices is to cover the cost of the commissions going to the marketing firm.

Those fees can add tens of thousands of dollars to the cost of a new apartment or house.

A large part of those commissions are often then passed on to mortgage brokers, accountants or financial planners who refer their clients to the marketing firms.

The Real Estate Institute of Australia (REIA) said it has been “ferociously lobbying” both the federal and state governments to impose more regulation on this type of property sales tactic.

In the meantime, the REIA’s president, Malcolm Gunning, said clients need to do their homework if offered a property deal that sounds too good to be true.

“This is really aimed at, I suppose, the new investor or the lazy investor who really doesn’t want to go out and do their own due diligence,” he said.

“You should always cross-check. You should go off, walk down to your local real estate agent who’s been there for 25 years and say, ‘if I buy this property, what rent can I get for it and what in your opinion is the current market value?’

“So at least you’re making an informed decision. Don’t rely just on one source of information.”

So if an adviser or broker tries to sell you a property investment, it is worth asking who is paying theirs.

Whats In A Home Price Number?

So, we have new data from both CoreLogic and Domain on home price growth.  The problem is we are getting somewhat different results, driven presumably by their different methodologies. But is does make it hard to decode the true story in some locations.  Trends are still pointing down though.

Here is a plot of changes in values over the past year, based on CoreLogic’s December 2017 and January 2018 data, and the December 2017 data from Domain.

Domain looks more bullish in the eastern states, Brisbane apart. Corelogic is showing a fall between December and January in most east coast states.

Hobart is the winner, but is it 17% or 12%, a large variation.  And is Canberra 8% or 4%?

Perth and Darwin and stuck in negative territory.

My take out is that these numbers are dynamic, and should not be taken too seriously, though the trend is probably the best indicator.

Perhaps their respective analysts can explain the variations. I for one would love to understand the differences.

Its a pity we have to wait so long for the ABS price data.  But then again, that just adds another data point, which does not directly match.

Another case of being careful with the data!

Industry body urges big banks to drop rates

From The Adviser.

The head of the Finance Brokers Association of Australia has called on the big banks to drop home loan rates.

FBAA executive director Peter White recently welcomed moves from non-banks to drop interest rates, but he stated that he’s “disappointed” that major banks haven’t followed suit.

“It is good to see the non-banks, second-tier and small lenders supporting home borrowers,” Mr White said this week.

“But at the same time, it is disappointing the big banks like ANZ seem disinterested in trying to work with borrowers by doing the opposite and putting their rates up.”

The FBAA executive warned banks not to “stab borrowers in the back” with “unjustified” rate rises and out-of-cycle interest rate changes.

“We hope in 2018 the big banks remember where their profits come from, and that is borrowers,” the executive director added.

However, Digital Finance Analytics principal Martin North told The Adviser that he expects the banks to increase, not decrease, rates, adding that a rate reduction wouldn’t be “feasible”.

“It’s not really feasible to cut rates in this situation when in fact I think we’re going to see rates rising,” Mr North said.

“Many borrowers can get extremely low rates at the moment, so I’m not sure there’s a need to slash rates further, and I’m not sure the banks will be able to because they’ve got margin compression going on behind the scenes.”

The economist believes that major banks are opting to “selectively” discount rates for specific borrowers as a way to “protect their margins”.

“[When] the interest-only books were repriced, that gave large banks, in particular, a bit of a war chest to be able to discount deeply, to offer new loans to targeted new customers. And that’s what’s playing out at the moment,” Mr North added.

“The fact is that the majors have tended to protect their margins and selectively discount loans to new customers.”

Mr North also advised borrowers to “shop around” to avoid the high rates offered by the major lenders.

The principal said: “A lot of the non-banks and also some of the customer-owned players have better rates than the majors, so if you are looking for a loan, shop around and go to some of those guys to get a better rate.”

APRA releases CBA Prudential Inquiry Progress Report

The Australian Prudential Regulation Authority (APRA) today released the Progress Report by the Panel appointed by APRA to conduct a Prudential Inquiry into the Commonwealth Bank of Australia (CBA).

In August last year, APRA established the Prudential Inquiry to examine the frameworks and practices in relation to the governance, culture and accountability within the CBA group, in light of a number of incidents which damaged the reputation and public standing of CBA. The Panel was subsequently appointed in September and the Inquiry began work in October.

The Progress Report provides an update on the status of the Inquiry and outlines the methodology that the Panel has adopted to address the Terms of Reference.

The Panel notes in its report that: ‘issues of governance, culture and accountability in a large financial institution are complex and interwoven, and the Panel does not consider it appropriate to draw conclusions, even preliminary ones, before this work is completed and all relevant evidence collected and carefully evaluated. Accordingly, the Panel will reserve its substantive findings and recommendations for inclusion in the Final Report, which will be provided to APRA by 30 April 2018.’

APRA Chairman Wayne Byres welcomed the update provided by the Panel on the extensive investigations currently underway.

“As the Panel has noted, issues of governance, culture and accountability in large organisations are complex to assess. APRA is pleased the Panel is taking a thorough and considered approach to the important task it has been given,” Mr Byres said.

The Panel comprises Dr John Laker AO, Professor Graeme Samuel AC and Jillian Broadbent AO.

The Panel is due to provide a final report to APRA by 30 April 2018.

The Progress Report is available here: CBA Prudential Inquiry Progress Report (PDF)

The Sydney Melbourne Home Price Divide

The latest data from Domain highlights the difference between the Sydney and Melbourne home prices movements.   The question is, will Melbourne follow Sydney’s lead, and slow in the months ahead, or chart a different path?

Sydney’s median house price, $1,179,519, increased by 0.5 per cent over the quarter and 4 per cent over the year.

HSBC chief economist Paul Bloxham said Sydney was getting less support from international and domestic migration compared with Melbourne. “A cooling in investor interest has also been more apparent in the Sydney market.”

The gap between house prices in Melbourne and the harbour city continues to narrow. Over the latest quarter the difference was reduced to $276,000, the lowest in three years.

Melbourne’s median shot up 3.2 per cent to $903,859 in the December quarter, according to the Domain Group’s latest State of the Market report. Prices have risen every quarter for nearly five and a half years.

Market Economics managing director Stephen Koukoulas said “even though there has been a bit of a tightening in credit for investors, in terms of the amount that is lent and interest-only loans, it doesn’t appear to have had a significant impact in Melbourne”.

Melbourne was again a strong performer compared to most other capital cities, with only Hobart and Canberra posting higher growth.

Domain Group data scientist Nicola Powell said Melbourne’s most affordable regions — the west, north west and south east — had recorded the strongest price growth off the back of heightened first-home buyer activity.

Worth also noting that the strongest growth areas are also the highest in terms of mortgage stress, according to our analysis. So household debt remains extended, and the risks are rising.

Even in the CBD, a market many consider to be overheated, prices for apartments climbed 1.9 per cent over the December quarter,. But compare this to a significant fall in Brisbane apartments, so it is important to get granular when examining the data.

Brisbane unit prices have continued their downward slide, down to $385,955; a fall of 2.2 per cent for the quarter and 4.4 per cent for the year. Here units are actually at a four-year low, it’s the steepest yearly fall since June 2001. Domain says “we’re starting to see developers start to respond to the oversupply, they’re delaying some projects and not starting some either”. Greater Brisbane’s lacklustre performance, as revealed in the latest Domain Group State of the Market Report, shows median house prices have fallen by 0.6 per cent across the five LGAs, which include Brisbane, Ipswich, Redland, Moreton Bay and Logan, to $548,918.

Hobart has been declared the unlikely star of Australia’s 2017 property market, charting a stellar 17.3 per cent growth rate in house prices, putting the usual mainland glitterati into the shade. Domain Group data scientist Dr Nicola Powell agrees. The strong inter-state migration to Hobart for both lifestyle reasons and the affordability of homes is driving up prices steadily to today’s record Hobart median house price of $443,521, she believes. And with the latest December 2017 quarter alone showing a price surge of 10 per cent, there’s no relief in sight.

Domain reports Canberra’s median house price surged by 5 per cent over the December quarter to a new record high of $753,516. The Canberra growth rate was the highest recorded of all the capitals with the exception of Hobart where the median increased by 10 per cent over the quarter.

But the resources slump turned Darwin into the country’s worst performer with a 7.4 per cent drop in its median house price to $565,696 and a 14 per cent plunge in its unit price to $395,279. It also hit Perth, with a house median fall of 2.5 per cent to $557,567, and its units 1.7 per cent to $369,402.

Perth’s median house price grew 0.5 per cent to $557,567 during the December quarter. However, prices fell 2.5 cent compared with the previous year. In the unit market, median prices grew one per cent to $369,402 – a 1.7 per cent decline year-on-year.

 

Fed Holds, But Signals More Rises Ahead

The Fed held their target range but confirmed its intent to lift rates ahead at Yellen’s last meeting as head. The bank signalled that it would push ahead on its monetary policy tightening path as economic activity has been rising at a solid rate, while inflation remained low but is expected to “move up” in the coming months. Most analysts suggest 2-3 hikes this year. The T10 bond yield continues to rise and is highest since 2014. Expect rates to go higher, putting more pressure on international funding costs.

Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‑month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

Population Ageing and the Macroeconomy

From The Bankunderground.

An unprecedented ageing process is unfolding in industrialised economies. The share of the population over 65 has gone from 8% in 1950 to almost 20% in 2015, and is projected to keep rising. What are the macroeconomic implications of this change? What should we expect in the coming years? In a recent staff working paper, we link population ageing to several key economic trends over the last half century: the decline in real interest rates, the rise in house prices and household debt, and the pattern of foreign asset holdings among advanced economies. The effects of demographic change are not expected to reverse so long as longevity, and in particular the average time spent in retirement, remains high.

An unprecedented demographic change…

Population ageing is typically summarised by the old age dependency ratio, the ratio of the population over 65 relative to the working population. In industrialised countries, this ratio has risen from under 15% in 1950 to over 30% in 2015, and is forecast to rise to 50% in the next 20 years (dark blue line in Chart 1). Looking at a few countries where population data is available from the 19th century, shown in the dashed lines in Chart 1, this trend is unprecedented. While falling birth rates do play a part, the trend is driven predominantly by increasing longevity. The same ageing process is also happening, albeit more slowly, in middle and low income countries.

Chart 1: Old Age Dependency Ratio across industrialised countries (%)

Note: The ratio is defined as population over 65 divided by population aged 20-64. The thick navy line shows aggregate data from the UN Population Statistics for 17 industrialised countries (Australia, Austria, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Switzerland, UK and USA), and dashed navy lines show the high- and low-fertility scenarios in their projections. Thin dashed lines show the historical data for Belgium, Denmark, France, Netherlands, Switzerland and UK from The Human Mortality Database.

From an individual perspective, this trend reflects an increasing fraction of life spent in old age. People that reach retirement age can now look forward to living a further 20 years, on average. Assuming no change in the retirement age, this number is projected to rise to almost 30 years for generations born 20 to 30 years from now. Consider that when Bismarck, Lloyd George and others pioneered state pensions over a century ago, workers were lucky merely to reach retirement age. While raising the retirement age can work to stabilise the time spent in retirement relative to time spent working, the increases proposed in most advanced economies  are not yet enough to offset this rise in life expectancy.

… with a profound effect on desired wealth accumulation…

One of the primary ways that population ageing affects the economy is through savings and wealth accumulation. While many developed countries have some form of implicit transfers from workers to retirees through state pensions, private saving remains an important component of retirement income. This is evident in the life-cycle pattern of wealth holdings: in the United States, where the most data is available, wealth peaks close to retirement age and then falls gradually (Chart 2).

Chart 2: Net worth over the life-cycle, with and without housing (thousand US Dollars)

Note: The data is taken from Survey of Consumer Finances, averaged over 1989-2013. The dark solid line shows total net worth, and the light dashed line shows net worth excluding housing wealth.

The rise in life expectancy raises the economy’s desired level of wealth for two reasons. Firstly, people need to accumulate more wealth during their working life to fund their consumption over a longer expected retirement. In terms of the life-cycle profile of wealth, all else equal, this would mean that wealth rises more steeply and reaches a higher peak. Secondly, even without any change in behaviour over the life-cycle, the changing population age structure would imply rising aggregate wealth. Specifically, Chart 2 shows us that households accumulate much of their wealth by around age 50, and hold on to that wealth throughout retirement. Therefore, when adding up individuals’ wealth, the increasing share of people in these high-wealth stages of life will imply a higher aggregate level of wealth.

… With far-reaching macroeconomic implications…

What are the macroeconomic effects of this rise in wealth? In terms of a simple concrete example, household savings find their way to firms, who invest them in machines, structures and intangibles such as branding and research. To the extent that it is harder for firms to employ extra machines as profitably as existing ones, i.e. that the returns to these investments are diminishing at the margin, households get lower returns as their savings increase. In other words market interest rates are lower.

The effects of ageing do not stop there. As desired wealth rises, the demand for other assets, including for example housing, also rises, pushing up on prices. Borrowing also rises, in response to both the fall in the interest rate, which makes borrowing cheaper, and the rise in house prices, as younger and less wealthy households borrow to buy housing. Within open economies, countries that are ageing relatively faster will accumulate assets in countries that are ageing relatively more slowly. This would explain why rapidly ageing countries, like Japan or Germany, are lending money to relatively younger countries, such as Australia.

While the mechanism described above is, of course, simplified, there is evidence that the ratio of capital-to-GDP is indeed much higher now than in the past (Chart 3). This provides additional evidence in favour of our underlying mechanism.

Chart 3: Measures of Capital-to-GDP in industrialised countries (Index)

Note: The blue line shows an index of the ratio of the capital stock to value added in the US business sector from Fernald (2014), equal to 1 in 1947. The red line shows an index of the ratio of capital services to GDP for 19 OECD countries, which, for comparison, we normalise to equal the Fernald measure in 1985 when the series begins.

… which are quantitatively significant

In a recent staff working paper, we have embedded the mechanisms described above in a life-cycle model, in order to quantify these effects for industrialised countries. Households in our model follow the life-cycle patterns of work, home ownership and wealth that we see in the data. This means we take as given that retirees keep their high level of wealth, and assume that future retirees will do the same. We assume that households know their life expectancies accurately, take account of current and expected house prices and interest rates, and hence plan ahead for their future consumption. This implies that households are able to save more in anticipation of their longer retirements, rather than having to work longer or give up their consumption in old age.

In equilibrium, the real interest rate adjusts to balance the supply of capital from the household with the demand from firms. This sets to one side the fact that, in practice, there is a large spread between the risk-free interest rate in financial markets and the interest that firms earn on new investments. This spread is comprised, among other things, of various premia for liquidity and risk, and profits that firms earn in excess of their costs, which we abstract from. House prices also adjust to balance demand for housing with a supply that we assume is fixed per head.

We allow birth and death rates to fall in line with UN data and projections for industrialised countries, as defined in Chart 1. This will be the only external driver of the dynamics in our model. We set the model to match the level of interest rates, and some other aggregate variables in the 1970s, and then measure how the demographic trends have affected the economy since then.

We find that demographic change alone can explain 160bps of the 210bps decline in interest rates since the early 1980s measured by Holston et al. (2017). The model predicts an increase in house prices of over 45% since 1970, corresponding to around 75% of the change observed in the data (Chart 4a). It also explains the doubling of the private debt-to-GDP ratio between 1970 and the start of financial crisis, an increase of around 45pp (Chart 4b). These results confirm that ageing does have a sizeable economic impact. Implications for cross-country imbalances are also important: the pattern of foreign asset accumulation (net borrowing and lending) across industrialised economies predicted by the model explains almost 30% of the variation observed in 2010.

Chart 4: House prices and gross private debt-to-GDP in the model and in the data

 

Note: House prices are shown in percentage deviation from the 1970 value, and private debt-to-GDP is shown as a percentage. In both cases, the blue solid lines show the results of our model simulations and red dashed lines show the equivalent series in the data.

Finally, the model allows us to gauge the effects of demographics going forward, based on the projections in the UN data. Importantly, these effects are set to increase over the future. The retirement of baby boomers is sometimes cited as potentially driving a decrease in aggregate savings. This does not happen in our quantitative model, both because new generations are expecting to live ever longer into retirement, and are therefore saving more, and because we can expect that baby boomers will retain their high wealth levels throughout retirement. This means that population ageing will continue to keep long run interest rates lower than they would otherwise be, as long as life expectancy, in particular the expected duration of retirement, remains high.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.