Martin North – Page 1006 – Digital Finance Analytics (DFA) Blog

Can Indebtedness and Interest Rates Both Increase?

In FitchRating’s latest Global Perspective, James McCormack, Fitch’s Global Head of Sovereign Ratings highlights the dilemma facing the US where rates are low and debt is high. What happens when interest rates rise? Given that both household and corporate debt levels are much higher now, the potential exists for a much more negative impact in terms of debt sustainability and economic performance.

Private sector deleveraging has been a critical feature of the post-crisis US economic recovery, and will remain an important consideration for growth and stability as interest rates move higher. Borrowers have benefited from a more-than 30-year trend of falling rates, but the eventual reversal will test the degree to which private sector balance sheets have been strengthened in the post crisis period. With debt levels still high by historical standards, higher interest rates may have a pronounced impact on growth in the period ahead.

A Cycle Ends: Meaningful Deleveraging

The increase in household debt by 30 percentage points of GDP between 2000 and 2008 was unprecedented, as has been the subsequent deleveraging (see chart 1).

The previous 30 percentage point increase took more than 40 years, and there had never been a meaningful deleveraging prior to 2009. At end-2014, household debt was back to its 2002 level as a share of GDP, and below its 2008 peak in nominal terms. A similar, though less marked, pattern is evident in the corporate sector, unlike in previous credit cycles when corporate debt levels were more volatile than those of households. Corporate debt is now lower than in 2009 as a share of GDP, but 12% higher than the pre-crisis peak in nominal terms.

The Long View: Lower Rates Allowed for Higher Debt

Taking a much longer view, even accounting for post-crisis reductions, household and corporate debt levels have trended higher since the early 1950s (when data became available). Moreover, it is widely accepted – if not explicitly acknowledged – that a continuation of this trend is a sign the US economy is getting back to “normal”. The resumption of private sector credit growth on the back of improved balance sheets is a big part of the narrative of the US recovery, and a meaningful difference with conditions in the Eurozone. Historical interest rate developments provide insight to the steady run-up in US debt, and are a basis of concern looking forward. Both nominal and real medium-term interest rates (approximated by 10-year US Treasury yields) have been falling since the early 1980s. Over the same period, there have been matching declines in effective interest rates faced by the household and corporate sectors (see chart 2).

Effective rates are calculated using BEA data on Interest Paid and Received by Sector, and Flow of Funds data on outstanding debt stocks. Critically, for the last 30 years, falling interest rates have offset the effects of higher debt levels to keep interest service ratios manageable (see chart 3).

There is a strong historical relationship between US economic growth and interest rates in both real and nominal terms. Over the last 50 years real GDP growth and 10-year US Treasury yields (using the GDP deflator) averaged 3.1% and 3.0%, respectively. In nominal terms they averaged 6.7% and 6.6%. On this basis, with 10-year Treasuries yielding less than 2%, they appear low by historical standards. Current conditions are certainly not unique. There have been periods when 10-year Treasury yields were consistently lower than economic growth. The last episode was the mid-2000s, when a global savings glut led to what Alan Greenspan described as a “conundrum”, whereby increases in the Fed Fund rate from 2004 were not matched by 10-year yields. With reasonably strong US growth at the time, households and corporates responded as might be expected – they borrowed more. Private credit growth subsequently outpaced nominal GDP growth and was one of the contributing factors of the global financial crisis.

The critical question is what will happen to 10-year Treasury yields and the effective interest rates faced by the corporate and household sectors as monetary policy is tightened in the current cycle? With smaller current account surpluses in Asia and among Middle East oil exporters, it seems less probable that a global savings glut will continue to hold US rates down. Despite the deleveraging that began in 2009, neither the household nor corporate sector is particularly well placed for a higher interest rate environment. Household interest payments as a share of GDP are now at the same level as the mid-1970s, when debt was lower by 35 percentage points of GDP. Corporate sector debt has increased by less, but interest payments are also at mid-1970s levels. It appears that for the first time since the early 1980s, the outlook for the US economy may be characterised by simultaneous increases in debt levels and effective interest rates. The difference now, however, is household and corporate debt levels are much higher, suggesting the potential for a much more negative impact in terms of debt sustainability and economic performance.

Home Prices Higher In April – CoreLogic RP Data

CoreLogic RP Data April Home Value Index results confirmed that values across Australia’s combined capital cities increased by 0.8 per cent in April 2015, down from a 1.4 per cent month on month increase in March. Overall dwelling values shifted higher over the past month across every capital city except Canberra where values showed a 1.5 per cent drop over the month.

According to the April Home Value results, capital city dwelling values have been trending higher over the past 35 months, recording a cumulative increase of 25.3 per cent between the end of May 2012 and April 2015. While the combined capitals trend of dwelling value growth has been substantial, the rate of growth across the Sydney housing market stands head and shoulders above the other capital cities over the cycle to date. Sydney dwelling values are now 40.2 per cent higher relative to the May 2012 trough. If you factor in the previous 2009/10 phase of growth, Sydney values are now up 65.4 per cent post GFC. Melbourne is the only other capital city that comes close to this measure where dwelling values are 52.3 per cent higher post GFC. The next highest rate of growth is Darwin where values have moved 26.5 per cent higher, followed by Canberra (19.8%), Perth (15.2%), Adelaide (12.2%), Brisbane (8.0%) and Hobart (1.2%). The rate of growth in Perth and Darwin has slowed substantially in line with the wind down of major infrastructure projects associated with the resources sector and the housing market in Canberra has also softened post federal election.

The performance of houses versus apartments has shown some interesting trends of late. Detached homes are continuing to outperform the multi-unit sector, with capital city house values up 8.3 per cent over the past year while unit values have risen by a lower 5.6 per cent. This trend is more noticeable in the key growth markets of Sydney and Melbourne. Sydney house values are up 15.5 per cent over the past year while unit values have risen by 9.7 per cent. The over-performance of houses compared with units is more apparent in Melbourne where house values are 7.6 per cent higher over the year compared with a growth rate of just 1.9 per cent across the unit market. A similar trend is evident across most of the capital cities and can likely be attributed to the higher supply levels in the apartment markets which are keeping a lid on the rate of capital gain.

Most other housing market indicators remain strong. Auction clearance rates have surged to new record highs after the February rate cut and have trended slightly higher over the final two weeks of April. Additionally, the number of homes being advertised for sale has been trending lower, particularly in Sydney where listing numbers are now lower than the number of properties being advertised for sale in Melbourne, Brisbane and Perth. The short supply of advertised homes in Sydney is likely to be one of the key factors driving local dwelling values higher, with buyers pressured to make a purchase decision quickly with minimal negotiation on asking prices due to few alternative housing options available for sale.

The performance of the housing market is increasingly varied across the capital cities. Sydney is continuing to dominate the headlines with such a high rate of capital gain, while Melbourne is also showing a solid performance. At the other end of the spectrum, Perth, Darwin, Hobart and Canberra are showing weaker results while Brisbane and Adelaide and are roughly keeping pace with inflation. In fact, outside of Sydney and Melbourne, the next highest rate of annual capital gain can be found in Brisbane where dwelling values are up a comparatively paltry 2.2 per cent.

Residential Building Hotspots – HIA

The latest HIA/ACI Population and Residential Building Hotspots Report shows Western Australia again dominating the latest league table, with Victoria and New South Wales also strongly represented. Nationally, a “Hotspot” is defined as a local area where population growth exceeds the national rate and where the value of residential building work approved is in excess of $100 million. Local areas featuring on the Building Momentum shortlist have demonstrated consistently strong rates of population growth in recent years in addition to an increase in the estimated value of new home building work approved in 2014/15.

Six of the top twenty Hotspots were in Western Australia, followed by Victoria with five and New South Wales with four. For a second consecutive year, it was the Australian Capital Territory that was home to Australia’s number one building and population Hotspot – the territory’s South West area. Second place was the Northern Territory’s Palmerston South area. The ACT was also home to Australia’s number three Hotspot, the suburb of Crace.

This year’s Hotspots report also provides a Building Momentum shortlist which identifies a number of regions where further upward momentum in building activity is set to occur in 2015. Strong potential is evident for local areas in NSW in particular, while WA and Victoria also feature quite broadly. In contrast, the ACT does not feature on this shortlist, signalling that the experience of recent years – where a number of ACT areas have been strongly represented among the Nation’s Top 20 Hotspots – is unlikely to be replicated next year.

Length of Zero Interest Rate Policy Reflects Diminished Fundamentals – Moody’s

According to Moody’s, recently markets discovered that there was only a limited speculative demand for 10-year European government bonds yielding less than 1%. Unless forced to do so by an investment mandate, it’s highly unlikely that many long-term investors had been loading up on European government debt yielding less than 1%. Despite their latest climb, European government bond yields remained low compared to what otherwise might be inferred from fundamental drivers excluding European Central Bank (ECB) demand. ECB purchases have been substantial and are scheduled to be so. For example, the ECB still intends to purchase another one trillion euro of European bonds by the autumn of 2016.

Over the past week, the 10-year German government bond yield rose by 22 bp to 0.38%. In near lock step fashion, the 10-year US Treasury yield increased by 19 bp to 2.10%. The unexpected rise by Treasury bond yields helped to trigger an accompanying 0.9% drop by the market value of US common stock.

We still hold that the forthcoming upswing by US bond yields will more closely resemble a mild rise, as opposed to a jarring lift-off. Though financial markets are likely to overreact to the first convincing hint of a higher fed funds rate, the record shows that the market value of US common stock does not peak until several years after the initial rate hike. Yes, payrolls are growing, but the quality of new jobs may be lacking, according to the subpar growth of employee compensation and below-trend income expectations. Thus, the reaction of household expenditures, including home sales, to the expansion of payrolls and still extraordinarily low mortgage yields falls considerably short of what occurred during previous business cycle upturns. In turn, the upside for Treasury bond yields is limited. The 10-year US Treasury yield is likely to spend 2015’s final quarter in a range that is no greater than 2.25% to 2.50%.

When the federal funds rate target was first lowered to its current range of 0.00% to 0.25% in December 2008, nobody dared to predict that this record low target would hold well into 2015. Few, if any, appreciated the extent to which the drivers of expenditures growth had been weakened not only by a diminution of business and household credit quality, but also by heightened global competition and an aging population. Three overlapping and unprecedented episodes of quantitative easing have made the length of the nearly 6.5year stay by the Fed’s zero interest rate policy all the more remarkable. Neither the Fed’s $3.8 trillion net purchase of bonds since mid-2008 nor roughly $800 billion of fiscal stimulus was able to spur expenditures by enough to allow for the removal of an ultra-low fed funds rate target.
In stark contrast, fed funds’ previous bottom of 1% in 2003-2004 lasted for only 12 months. And when fed funds troughed at the 3% during late 1992 into early 1994, its duration was slightly longer at 17 months. The US economy’s decidedly positive response to each earlier bottoming of fed funds helps to explain their much shorter durations.

Long-term growth slows markedly

Amazingly, despite humongous monetary stimulus, as well as considerable fiscal stimulus, the moving yearlong sum of real GDP has grown by only 2.2% annualized since the Great Recession ended in June 2009. For comparably measured serial comparisons, 23 quarters following the expiry of the three downturns prior to the Great Recession, the average annualized rates of real GDP growth were 2.9% as of Q3-2007, 3.4% as of Q4-1996, and 4.8% as of Q3-1988. The downshifting of the average annual rate of growth by the 23rd quarter of an upturn lends credibility to the secular deceleration argument. If there is any good news it may be that the prolonged deceleration of US economic growth may be bottoming out. That being said, Q1-2015’s lower than expected estimate of real GDP increases the likelihood that 2015 will be the 10th straight year for which the annual rate of US economic growth failed to reach 3%. Such a stretch lacks recent precedent.

US real GDP will probably average a 1.5% annualized increase during the 10-years-ended 2015. Previous 10year average annualized rates of real GDP growth averaged 3.4% as of 2005, 3.0% as of 1995, and 3.5% as of 1985. Beginning and concluding with the spans-ended 1957 through 2007, the 10-year average annualized rate of real GDP growth averaged 3.4%. Most baby boomers will not live long enough to observe another average annual growth rate of at least 3% over a 10-year span.

Corporate credit heeds the diminished efficacy of stimulus

The corporate credit market is well aware of how so much monetary and fiscal stimulus supplied so little lift to business activity. In turn, credit spreads are wider than otherwise given a benign default outlook, partly because of a loss of confidence in the ability of policy actions to quickly spur expenditures out of a macroeconomic slump. In the event an adverse shock rattles the US economy, just how effective would additional monetary stimulus be at reviving growth?

Moreover, a still elevated ratio of US government debt to GDP might delay the implementation of fiscal policy by a Congress that remains skeptical of the effectiveness of increased government spending and a Presidency that is adverse to tax cuts. Also, even if Washington were to agree on fiscal stimulus, foreign investors, who now hold 47% of outstanding US Treasury debt, may be unwilling to take on more obligations of the US government unless compensated in the form of higher US Treasury bond yields. In all likelihood, an accompanying rise by private-sector borrowing costs would reduce the lift supplied by fiscal stimulus.

RBNZ Bulletin Covers Capital Markets

The New Zealand Reserve Bank today published an article in the Reserve Bank Bulletin that describes New Zealand’s capital markets, and the role they play in the functioning of financial markets and the real economy. The article is quite comprehensive, and worth reading becasue it describes the financial instruments and market participants involved, and analyses a unique dataset to provide some detail on the size of both the bond and equity markets, which together comprise local capital markets. We summarise some of the discussion.

Capital markets are the part of the financial system that involve buying and selling long-term securities – both debt (bonds) and equity instruments. Capital markets are used to fund investment or to facilitate takeovers, and to provide risk mitigation (for example via derivatives) and diversification. There is no strict definition of ‘long-term’; Potter (1995) defines capital market instruments as having a maturity of greater than one year, and we retain this classification here, noting that capital market instruments may also have no maturity date (as in the case of perpetual bonds or equity). This article further classifies the domestic capital market as all resident entities issuing into the local economy in New Zealand dollars (NZD) . The article also touches on resident entities issuing bonds offshore, and non-resident entities issuing into New Zealand in NZD.New Zealand’s capital markets are an integral part of the domestic financial system. The previous Reserve Bank Bulletin articles describing New Zealand’s capital markets were published 20 years ago. The landscape has changed dramatically since then – local capital markets have grown substantially, although remain small compared with those in many other advanced economies.

The Reserve Bank has a wide-ranging interest in New Zealand’s capital markets. The Financial Stability Report (FSR), for example, reports on the soundness and efficiency of the financial system, including capital markets. Capital markets that function effectively are important for the way monetary policy affects the wider economy. The Reserve Bank’s prudential regulation of financial institutions can also influence the type and nature of capital market instruments that develop in the local market.

Section two of the article describes capital markets in general, and defines New Zealand’s capital markets in a global context. The instruments and players involved are explained. Section three discusses why capital markets are important for any economy, while section four highlights the Reserve Bank’s interest in capital markets. Section five describes New Zealand’s capital markets and uses a unique dataset to provide detail on the size of the non-government bond market in particular. Section six notes developments since the 2009 Capital Markets Taskforce review.

One interesting piece of data relates to bond issuance. The total amount of bonds outstanding in the local market (excluding Kauris) has more than doubled since 2007 in nominal terms, rising from just over $50 billion (30 percent of GDP) at the start of 2007 to $121 billion. More than two-thirds of this rise is due to an increase in central government debt, while nearly 20 percent of the increase represents bond issuance by banks. The increase in government bond issuance is linked to the shift from fiscal surpluses to deficits during the Global Financial Crisis (GFC), and further issuance following the Christchurch earthquakes.

New Zealand banks increased their issuance of long-term debt sharply in the immediate post-GFC period. This followed from a number of changes in the global environment, including the risk of a negative credit rating from international rating agencies stemming from a reliance on short-term funding, a lack of global liquidity, and a cessation of some wholesale funding markets during the depth of the GFC (increasing the risk of a failure to roll over upcoming funding needs). In addition, New Zealand registered banks are now required by the Reserve Bank to raise a greater proportion of funding that is likely to remain in place for at least one year, as part of the prudential liquidity policy introduced in 2009. The Reserve Bank’s prudential liquidity policy was implemented to reduce the risk posed to New Zealand’s banking system by an overreliance on short-term wholesale market funding.

As at October 2014, the New Zealand (central) government sector had issued 61 percent of New Zealand’s bonds outstanding (figure 6). By comparison, the share of the local government sector was 8.5 percent, with 18.5 percent issued by banks or other financial institutions and 9 percent by non-financial corporates. SOEs comprise the remaining 3 percent. This breakdown has changed markedly since 2007; as previously noted, central government debt makes up a much larger share today, while the proportion of non-financial corporate bonds has fallen from 19 percent to its current level of 9 percent of the total. Although the nominal amount of bonds outstanding has increased for all sectors, nonfinancial corporate bonds have decreased as a share of GDP, falling from 5.7 percent to 4.5 percent currently (possibly reflecting weaker overall demand for business credit in the past five years). Note that figure 6 does not include bonds issued by New Zealand entities in offshore markets; if included, the share of government bonds would decrease.

Looking ahead, New Zealand’s equity and bond markets have grown in size and depth in recent years. Despite this, the size of New Zealand’s capital markets remains small and underdeveloped by international standards, while the banking system continues to dominate funding for New Zealand firms. On the one hand, the relatively small size of New Zealand’s capital markets might simply reflect the small size of the economy: some economies simply lack scale to support a flourishing capital market.

Laeven (2014) argues that, “in an increasingly globalised world, not every country needs to develop a fully-fledged physical capital market at home. The optimal balance between local capital market development and integration in global capital markets will depend on country circumstances, such as economic size and stage of development” (p.19). As noted in this article, larger New Zealand corporates already have access to global markets – both public debt markets and private placements.

On the other hand, many believe that further development of both equity and bond markets in New Zealand would help to underpin economic growth (CMD Taskforce, 2009). Indeed, capital market activity over the past few years has been heavily influenced by a wide range of continuing regulatory and policy initiatives to support New Zealand’s equity and bond markets. Looking ahead, the growth of KiwiSaver scheme funds and the recent partial privatisation of SOEs could add further depth and liquidity to the domestic equity market, and in turn increase international interest and participation. In addition, the development of an alternative public growth market, introduced last year by the NZX, could help to encourage more SMEs to raise funds via public listing (by offering lower compliance costs). Other policy and regulatory initiatives including formalising crowd funding via crowd funding licences issued by the FMA, could further serve to reduce capital-raising costs for small firms. That said, most of the regulatory initiatives are very recent, and at this point, it is difficult to assess how much difference these changes will make over the longer term

BIS On Financial Regulation

Interesting panel remarks at the IMF conference “Rethinking macro policy III: progress or confusion?” by Jaime Caruana, General Manager, Bank for International Settlements in Washington DC. The comments were entitled “The international monetary and financial system:eliminating the blind spot”.

Introduction

Thank you for inviting me to discuss the international monetary and financial system (IMFS) at this engaging conference. The design of international arrangements suitable for the global economy is a long-standing issue in economics. The global financial crisis has put this issue back on the policy agenda. In my panel remarks, I would like to concentrate on an important blind spot in the system. The current IMFS consists of domestically focused policies in a world of global firms, currencies and capital flows – but are local rules adequate for a global game ? I shall argue that liquidity conditions often spill over across borders and can amplify domestic imbalances to the point of instability. In other words, the IMFS as we know it today not only does not constrain the build-up of financial imbalances, it also does not make it easy for national authorities to see these imbalances coming.

Certainly, some actions have been taken to address this weakness in the system: the regulatory agenda has made significant progress in strengthening the resilience of the financial system. But we also know that risks and leverage will morph and migrate, and that the regulatory response by itself will not be enough. Other policies also have an important role to play. In particular, I shall argue that, in order to address this blind spot, central banks should take international spillovers and feedbacks – or spillbacks, as some may call them – into account, not least out of enlightened self-interest.

Local rules in a global game

Let me briefly characterise the present-day IMFS, before describing the spillover channels. In contrast to the Bretton Woods system or the gold standard, the IMFS today no longer has a single commodity or currency as nominal anchor. I am not proposing to go back to these former systems; rather, I will argue in favour of better anchoring domestic policies by taking financial stability considerations into account, internalising the interactions among policy regimes, and strengthening international cooperation so that we can establish better rules of the game.
So what are the rules of the game today? If there are any rules to speak of, they are mainly local. Most central banks target domestic inflation and let their currencies float, or follow policies consistent with managed or fixed exchange rates in line with domestic policy goals. Most central banks interpret their mandate exclusively in domestic terms. Moreover, the search for a framework that can satisfactorily integrate the links between financial stability and monetary policy is still work in progress with some way to go. The development and adoption of such a framework represent one of the most significant and difficult challenges for the central bank community over the next few years.

When one looks at the international policy discussions, the main focus there is to contain balance of payments imbalances, with most attention paid to the current account (ie net flows) and not enough attention to gross flows and stocks – ie stocks of debt. This policy design does not help us see – much less constrain – the build-up of financial imbalances within and across countries. This, in my view, is a blind spot that is central to this debate. Global finance matters – and the game is undeniably global even if the rules that central banks play by are mostly local!

International spillover channels

Monetary regimes and financial conditions interact globally and reinforce each other. The strength and relevance of the spillovers and feedbacks tend to be underestimated. Let me briefly sketch four channels through which this happens. The first works through the conduct of monetary policy: easy monetary conditions in the major advanced economies spread to the rest of the world via policy reactions in the other economies (eg easing to resist currency appreciation and maintain competitiveness). This pattern goes beyond emerging market economies: many central banks have been keeping policy interest rates below those implied by traditional domestic benchmarks, as proxied by Taylor rules.

The second channel involves the international use of currencies: most notably, the domains of the US dollar and the euro extend so broadly beyond their respective domestic jurisdictions that US and euro area monetary policies immediately affect financial conditions in the rest of the world. The US dollar, followed by the euro, plays an outsize role in trade invoicing, foreign exchange turnover, official reserves and the denomination of bonds and loans. A key observation in this context is that US dollar credit to non-bank borrowers outside the United States has reached $9.2 trillion, and this stock expands on US monetary easing. In fact, under this monetary policy for the United States, US dollar credit has been expanding much faster abroad than at home (Graph 1, top right-hand panel).

Third, the integration of financial markets allows global common factors to move bond and equity prices. Uncertainty and risk aversion, as reflected in indicators such as the VIX index, affect asset markets and credit flows everywhere. In the new phase of global liquidity, where capital markets are gaining prominence and the search for yield is a driving force, risk premia and term premia in bond markets play an important role in the transmission of financial conditions across markets. This role has strengthened in the wake of central bank large-scale asset purchases. The Federal Reserve’s large-scale asset purchases compressed not only the US bond term premium, but also long-term yields in many other bond markets. More recently, the new programme of bond purchases in the euro area put downward pressure not only on European bond yields but apparently also on US bond yields, even amid expectations of US policy tightening.

A fourth channel works through the availability of external finance in general, regardless of currency: capital flows provide a source of funding that can amplify domestic credit booms and busts. The leverage and equity of global banks jointly drive gross cross-border lending, and domestic currency appreciation can accelerate those inflows as it strengthens the balance sheets of local firms that have financed local currency assets with US dollar borrowing. In the run-up to the global financial crisis, for instance, cross-border bank lending contributed to raising credit-to-GDP ratios in a number of economies.

Through these channels, monetary and financial regimes can interact with and reinforce each other, sometimes amplifying domestic imbalances to the point of instability. Global liquidity surges and collapses as a result. What I have just described is the spillovers and feedbacks – and the tendency to create a global easing bias – with monetary accommodation at the centre. But these channels can also work in the opposite direction, amplifying financial tightening when policy rates in the centre begin to rise, or even seem ready to rise – as suggested by the taper tantrum of 2013. Nevertheless, it is an open question whether the effect of the IMFS is symmetric in this regard, creating as much of a tightening bias as it does an easing bias. In both cases, it is important to try to eliminate the blind spot and keep an eye on the dynamics of global liquidity.

Policy implications: from the house to the neighbourhood

This leads to my second point, that central banks should take the international effects of their own actions into account in setting monetary policy. This takes more than just keeping one’s own house in order; it will also require contributing to keeping the neighbourhood in order. An important precondition in this regard is the need to continue the work of incorporating financial factors into macroeconomics. If policymakers can better manage the broader financial cycle, that would in itself already help constrain excesses and reduce spillovers from one country to another.

But policymakers should also give more weight to international interactions, including spillovers, feedbacks and collective action problems, with a view to keeping the neighbourhood in order. How to start broadening one’s view from house to neighbourhood? One useful step would be to reach a common diagnosis, a consensus in our understanding of how international spillovers and spillbacks work. The widely held view that the IMFS should focus on large current account imbalances, for instance, does not fully capture the multitude of spillover channels that are relevant in this regard.

An array of possibilities then presents itself in terms of the depth of international policy cooperation, ranging from extended local rules to new global rules of the game. To extend local rules, major central banks could internalise spillovers so as to contain the risk of financial imbalances building up to the point of blowing back on their domestic economies. Incorporating spillovers in monetary policy setting may improve performance over the medium term. This approach is thus fully consistent with enlightened self-interest. The need for policymakers to pay attention to global effects can be seen clearly in the major bond markets. Official reserve managers and major central banks hold large portions of outstanding government debt.

If investors treat bonds denominated in different currencies as close substitutes, central bank purchases that lower yields in one bond market also weigh on yields in other markets. For many years, changes in US bond yields have been thought to move yields abroad; in the last year, many observers have ascribed lower global bond yields to the ECB’s consideration of and implementation of large-scale bond purchases. Central banks ought to take account of these effects when setting monetary policy. However, even if countries do optimise their own domestic policies with full information, a global optimum cannot be reached when there are externalities and strategic complementarities as in today’s era of global liquidity. This means that we will also need more international cooperation. This could mean taking ad hoc joint action, or perhaps even developing new global rules of the game to help instil additional discipline in national policies. Given the pre-eminence of the key international currencies, the major central banks have a special responsibility to conduct policy in a way that supports global financial stability – a way that keeps the neighbourhood in order.

Importantly, the domestic focus of central bank mandates need not preclude progress in this direction. After all, national mandates in bank regulation and supervision have also permitted extensive international cooperation and the development of global principles and standards in this area.

Conclusion

To conclude, the current environment offers us a good opportunity to revisit the various issues regarding the IMFS. Addressing the blind spot in the system will require us to take a global view. We need to better anchor domestic policies by taking financial factors into account. We also need to understand and internalise the international spillovers and interactions of policies. This new approach will pose challenges. We have yet to develop an analytical framework that allows us to properly integrate financial factors – including international spillovers – into monetary policy. And there is work to be done to enhance international cooperation. All these elements together would help establish better global rules of the game.

The global financial crisis has demonstrated that international cooperation in crisis management can be effective. For instance, the establishment of international central bank swap lines can be seen as an example of enlightened self-interest. However, we must also recognise that there are limits to how far and how fast the global safety nets can be extended to mitigate future strains. This puts a premium on crisis prevention. Each country will need to do its part and contribute to making the global financial system more resilient – and I would add here that reinforcing the capacity of the IMF is one element in this regard. And taking international spillovers and financial stability issues into account in setting monetary policy is a useful step in this direction.

March Monthly Banking Stats Update

APRA published their monthly banking statistics for March. Overall housing lending was $1.336 trillion by the banks (the RBA number of $1.45 trillion includes the non banks). This was a rise of 0.59% in the month, with owner occupied loans lifting 0.46% and investment loans 0.84%. Investment loans accounted for 35.1% of all loans in the month. Looking at the individual bank data, there was little change, with CBA holding the largest share of owner occupied loans, and Westpac, investment loans. Macquarie continues its growth path.

Looking at the portfolio movements, ING and Suncorp both lost portfolio share, whilst Macquarie continues to expand at pace. Members Equity and Bendigo/Adelaide also grew well above the market average.

Looking at the annual growth rates, for owner occupied loans, Macquarie led the way (partly thanks to acquisition) and ANZ was the major with the largest growth.

On the investment lending side, where there is more interest in not exceeding the 10% “alert” level, we see that ANZ and Westpac were at 10%, whilst CBA and NAB were above the 10% mark. Macquarie and Members Equity continue to grow their investment lending book well above system. No doubt the regulators are having a quiet word! As APRA said, “strong growth in lending to property investors — portfolio growth materially above a threshold of 10 per cent will be an important risk indicator for APRA supervisors in considering the need for further action”

Talking about APRA, their supervisory lens also includes serviceability buffers – “loan affordability tests for new borrowers — in APRA’s view, these should incorporate an interest rate buffer of at least 2 per cent above the loan product rate, and a floor lending rate of at least 7 per cent, when assessing borrowers’ ability to service their loans. Good practice would be to maintain a buffer and floor rate comfortably above these levels”. So how come we do not get any reporting on this dimension? As discussed before, this should be addressed.

Deposits grew at 0.47%, so slower than lending, indicating that some banks are relying more on other funding avenues to support growth. Deposits rose by $8.6 billion to a total of 1.8 trillion. There was little relative movement amongst the major players in terms of share, though we do see deposit repricing in hand, with rates continuing to falling.

Individual movements are charted below for selected banks.

Finally, the credit card portfolio grew by $169 million in the month, and sits at $41,6 billion. Little change in the market shares reported this month.

Housing Lending Now Up $1.45 Trillion – RBA

The latest credit aggregates continues to show the same trends, with housing up again overall by 0.66%, but with investment lending still running at 0.9%, whilst owner occupied lending was 0.51% higher in the month. As a result, the share of investment loans rose again, to 34.46%, from 34.37% last month. So the housing investment skew continues. More food for thought against further interest rate cuts. Total housing lending is running at an annual growth rate of 7.3%, up from 5.9% this time last year.

Overall lending was 0.48% higher, with business lending growing just 0.19%, and personal credit 0.24%. Worryingly again we see a fall in the ratio of business lending to total credit, so once again, the banks are much happier meeting demand for house loans than helping business to borrow for productive purposes. We are not sure lower interest rates would stir business into action in the current environment, and with current lending policy and capital ratios in play. We think rates will stay on hold.

Sydney Rentals Unaffordable For Many – Anglicare

The Rental Affordability Snapshot (RAS) was originally developed by the Social Action Research Centre at Anglicare Tasmania to highlight the lived experience of looking for housing whilst on a low income. An audit of rental properties determines the extent to which on the nominated day a person on a low income is able to find housing that is both affordable and appropriate for their needs. The RAS has been coordinated by the national peak body, Anglicare Australia. This data relates to Sydney and the Illawara.

In April 2015, with the aim of highlighting the difficulty in finding an affordable and appropriate rental property for low income households. As part of this national project, Anglicare Sydney examined about 15,000 rental advertisements in Greater Sydney (including the Central Coast) and the Illawarra, over the weekend of the 11th April, using online and print media. The total number of listings has increased from more than 13,000 properties in the 2014 Snapshot and almost 14,000 properties in 2013. Results were sorted into 17 smaller Statistical Areas for analysis and reporting purposes. The findings revealed that for many households, finding appropriate and affordable housing is almost impossible.

Affordability of rental properties for people on income support: These households include single parents, people living with a disability, the elderly and frail aged, full-time students, and people struggling to find paid employment. For income support recipients, finding an affordable and appropriate rental dwelling which costs less than 30 percent of their household income is a difficult challenge, with few low-cost, private rental dwellings being available. If 2-bedroom properties were excluded for families with more than one child, there were only 52 unique properties in Greater Sydney and 19 in the Illawarra that were affordable and appropriate without placing them into rental stress (paying over 30 percent of income on rent). If the criteria were widened to include 2-bedroom properties for families with 2 children then 58 properties in Greater Sydney and 33 properties in the Illawarra were affordable and appropriate. Compared with previous results, the number of suitable rental properties (58) was similar in Greater Sydney (43 properties in 2014), although this remains less than one percent of total advertised properties. The number of affordable and appropriate properties in the Illawarra region (33) was also similar to 2014 (38 properties) and 2013 (42 properties). The vast majority of affordable and appropriate properties were located in the Outer Ring of Sydney (at least 20km from the CBD). It is concerning that there were no rental properties in Sydney that were suitable for single people on Youth Allowance, Disability Pension or Newstart without placing them into rental stress.

Affordability of rental properties for minimum wage households: Rental affordability was also examined for those people earning the minimum wage, including couple families, single parents and single people. If 2-bedroom properties were excluded for families with more than one child, there were 868 unique properties in Greater Sydney and 261 in the Illawarra that were affordable and appropriate without placing them into rental stress. If the criteria were widened to include 2-bedroom properties for families with 2 children then 2,302 properties in Greater Sydney and 521 properties in the Illawarra were affordable and appropriate. Compared with previous results, the number of suitable rental properties for people on the minimum wage has increased in Greater Sydney (up from 1,799 properties in 2014), while it has remained the same in the Illawarra Region (509 properties in 2014). While all Statistical Areas in Sydney contained at least one suitable property, the majority were still located further away from the CBD in areas such as the Central Coast, Blue Mountains or in South Western Sydney.

Payment of 30-45% of income as rent: Anglicare Sydney also explored the availability of rental properties in the 30-45%-of-income band that would place a household into rental stress. Using this criterion, there were 1,148 additional suitable listings in Greater Sydney and 310 in the Illawarra, where households relying on income support would have spent between 30 and 45 percent of their income. For households earning the minimum wage, there were 5,121 additional suitable listings in Greater Sydney and 298 in the Illawarra in the 30-45%-of-income band.

A range of policy solutions are needed to improve rental affordability for low income households, including the urgent need for increases in the supply of social housing, raising the rate of Commonwealth Rent Assistance and increasing the Newstart Allowance. There needs to be firm and long-term commitment to the supply of affordable housing from all levels of government, community and business sectors.

ABS Tweaks First Time Buyer Data Again

The ABS released updated data for housing finance for February 2015 today. As a result the number of first time buyers in the data changed a little. The chart below shows the variation on a monthly basis between the latest revisions, and the earlier figures. They warn that further changes should be expected. The net impact is a fall in the count of first time buyer loans written. The total number of loans recorded does not change.

From the December 2014 issue, the ABS changed its method of estimating loans to first home buyers by adjusting for under-reporting by some lenders that only report on those buyers receiving a first home owner grant. Data on first home buyers are collected by the Australian Prudential Regulation Authority (APRA) under the Financial Sector (Collection of Data) Act 2001. The ABS and APRA continue to work with lenders to ensure that loans to all first home buyers are identified in future, regardless of whether or not buyers receive a first home owner grant.

The model developed by the ABS for lenders who are under-reporting loans to first home buyers draws on the ratio of first home buyers to total loans for those lenders reporting correctly. The new estimation method will continue to be used in future releases. Monthly First Home Buyer Statistics are likely to be subject to future revision, as the modelled component is adjusted to reflect improved reporting by lenders.

The information paper Changes to the method of estimating loan commitments to first home buyers (cat. no. 5609.0.55.003), released on the ABS website on 4 February 2015, describes the new methodology and the extent of revisions to previously published estimates.