Welcome to the Property Imperative weekly to 6th October 2018, our digest of the latest finance and property news with a distinctively Australian flavour.
The main news this week centres on the rising long terms US Bond Rate, which signals higher interest rates ahead on the capital markets. After the global financial crisis, the US Federal Reserve has effectively been exporting extraordinarily loose monetary policy to markets across the world. As a result, one of the unintended consequences has been a growing number of asset bubbles around the world, especially in countries where central banks have been forced to run looser monetary policy than they might have wished. But now as rates lift, how will this unwind? And how quickly?
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The benchmark US 10-year Bond Rate ended at 3.23, up 0.18% and higher than it’s been since 2011. The longer 30 Year bond rate rose 0.25% to 3.40, again a recent record. So the question is, does this represent a change in sentiment, or just a slight adjustment?
Well, the most recent data from the US economy looks pretty strong still, with payroll gains for August revised to 270,000 from the 201,000 initially reported, while July was revised up to 165,000 from 147,000. The unemployment rate fell to 3.7%, a level not seen since 1969. But then, does unemployment reaching a 48-year low, indicate the economy could be plateauing? Average hourly earnings, an important number to gauge inflation, rose 2.8% year over year in September.
And nonfarm payrolls only rose by 134,000 last month, as reported by the US Labor Department, versus expectations for a gain of 185,000. This data is about as clear as mud, one analysts noted.
Bond yields have surged since the Federal Reserve added a quarter point to bring U.S. interest rates to between 2% and 2.5% last week in the third rate hike of the year. The Fed indicated another increase in December and Friday’s jobs numbers were still supportive to the central bank’s plans, analysts said. Plus, the consumer credit data out on Friday was also strong, signalling continued economic strength. So expectations for a Federal Reserve rate increase in December rose slightly to 77.7%.
We discussed the impact of these rising bond rates in our post “The Great Bond Sell-Off”. And we will have more to say on this later. But it’s worth noting the Fed is calling the US economy as sitting in the Goldilocks zone, and they see but few clouds on the horizon.
Higher interest rates increase bond yields, making non-interest bearing gold less attractive to investors. They also tend to boost the US dollar, making dollar-priced gold more expensive for holders of other currencies.
Despite that, Gold rose on Friday, advancing in the bullish $1,200 territory and notching its best weekly gain in six, with traders saying it was a sign of the precious metal’s return to its status as safe-haven reserve of the world. And in fact the disappointing U.S. nonfarm payrolls for September weighed on the dollar and prompted investors to seek alternative assets, including bullion and higher-yielding bonds.
Gold futures were up 0.42%, or $5.10 to $1,206.70, and the high of the day was $1,212.30, a peak since Aug. 26. For the week, December gold jumped 1.2%, its best weekly gain since the week ended Aug. 19.
Gold usually rises when the dollar declines, as it is denominated in the U.S. currency and is sensitive to moves in the greenback. The U.S. dollar index, which measures the greenback’s strength against a basket of six major currencies, was down by 0.13% to 95.31 after an intraday low at 95.18.
Among other precious metals, silver rose 0.62% to $14.68 per ounce, platinum rose 0.1 % to $825 and palladium increased 1.6% to $1,061.80 an ounce. In base metals, copper lost 0.49% to $2.764 a pound. Oil futures were slightly lower, down 0.05% to 74.29, and Bitcoin rose slightly up 0.65% to 6,635, but remains in the doldrums, and is not being seen as a robust alternative to Gold – yet!
The Dow Jones Industrial average fell 0.68% to 26,447, the NASDAQ fell 1.16% to 7,788 and S&P 500 fell 0.55% down to 2,886; all reflecting perceived greater risks as interest rates go higher, lifting funding pressures on corporates, and dampening demand for consumer goods and credit. Plus, the impact of the trade tariffs has to work through. The US volatility index, the fear index, rose 4.22% to 14.82 also signalling risk is on.
Elsewhere the euro was slightly higher, while sterling surged amid reports that the European Union and the UK are in the final Brexit negotiation stages. EUR/USD increased 0.09% to 1.1524 and GBP/USD rose 0.74% to 1.3117.
The dollar slid lower against the yen, with USD/JPY down 0.15% to 113.72.
The Australian dollar was lower, with AUD/USD down 0.31% to 70.53, while NZD/USD fell 0.57% to 64.43. The S&P/ASX 200 VIX, which measures the implied volatility of S&P/ASX 200 options, was up 1.65% to 11.43.
Locally, foreign exchange analysts have trimmed near-term forecasts for the Australian and New Zealand dollars, but they stayed upbeat on the long-term outlook despite the beating the two currencies have taken in recent weeks. A Reuters survey of 55 analysts saw median predictions for the Aussie cut to 72 cents on a one-month horizon, from 72.75 in the previous poll. But most are still holding to higher expectations around 75 cents, despite the fact Aussie has shed almost two cents since early September to hit 32-month lows. Probably, traders are using the Aussie as a hedge against tensions in emerging markets and the risks to the Chinese economy from U.S. tariffs. Of course the sudden surge in U.S. bond yields and hawkish commentary from the Federal Reserve has also driven the U.S. dollar higher more broadly. In contrast, the Reserve Bank of Australia (RBA) has repeatedly stated that its rates will remain at historic lows for some time to come.
“We see AUD/USD as a ’70-75 cents currency’ for a good while to come, but with risk now skewed toward spending at least some time sub-70 in the next six months or so if emerging market pressures do intensify significantly,” says NAB’s head of FX strategy Ray Attrill. In fact, only a handful of analysts in the Reuters poll forecast a fall under 70 cents and the lowest call was for 67 cents in three months.
We think this is courageous, to quote Sir Humphrey, given the pressures on the local economy here.
Sure the retail trade figures from the ABS were not too bad, with trend estimates rising 0.2 per cent in August 2018, following a 0.3 percent rise in July 2018, giving a 3.4 per cent. In trend terms, there were rises in New South Wales (0.3%), Victoria (0.3%), South Australia (0.2%), Queensland (0.2%), Tasmania (0.5%), and the Australian Capital Territory (0.3%). Western Australia fell (0.1%), whilst there was a more significant fall in the Northern Territory (-0.5%).
But Residential Building Approvals Fall Again down by 1.9 per cent in August 2018 in trend terms. In seasonally adjusted terms, total dwellings fell by 9.4 per cent in August, driven by a 17.2 per cent decrease in private dwellings excluding houses. Private houses fell 1.9 per cent in seasonally adjusted terms. The cause is simple, a significant fall in the number of new high-rise residential development applications, especially in Victoria. Recent falls in demand and prices suggests a significant reduction in momentum is on the cards there. We discussed this in our post “Building Approvals Dive In August 2018”.
Turning to property, CoreLogic says that last week 895 homes taken to auction across the combined capital cities, returning a final auction clearance rate of just 45.8 per cent, the lowest clearance rate we have seen since the week ending 10 June 2012 (42.0 per cent). Of course it was a long and sport laden weekend, so we should not take the data too seriously. Melbourne auction activity was subdued last week with just 70 homes taken to auction, returning a final clearance rate of 57.7 per cent across 52 results. There were 608 homes taken to auction in Sydney last week returning a clearance rate of just 43.8 per cent, the lowest clearance rate the city has recorded since December 2008 and the 6th time this year the clearance rate has fallen below 50 per cent. Across the smaller auction markets, clearance rates improved across Adelaide, while Perth and Tasmania saw no change in clearance rates week-on-week. Of the non-capital city auction markets, the Hunter Region was the best performing in terms of clearance rate, with 6 of the 11 reported auctions selling (54.6 per cent), followed by the Gold Coast with a 32.3 per cent clearance rate across 31 results.
The number of homes scheduled to go to auction this week is set to rise across the combined capital cities after last week’s public holiday and grand final slowdown with CoreLogic currently tracking 1,725 auctions, almost double the volumes seen last week. But do not expect much good news on the clearance rates.
And the September data also confirmed prices continue to fall, with national dwelling values falling 0.5% over the month, marking twelve months of consistently falling values across CoreLogic’s national hedonic home value index. Dwelling values tracked lower across five of the eight capital cities in September while five of the seven ‘rest of state’ regions recorded a fall in values over the month. CoreLogic head of research Tim Lawless said, “While the housing market downturn is well entrenched across Darwin and Perth where dwelling values remain 22.1% and 13.2% lower relative to their 2014 peak, Sydney and Melbourne are now the primary drag on the national housing market performance. They want to highlight this is not a crash though saying that since the national index peaked twelve months ago, dwelling values have fallen by 2.7%; and a slower rate of decline relative to the previous housing market downturn (Jun 2010 to Feb 2012) when national dwelling values fell by 3.0% over the first twelve months, declining 6.5% from peak to trough.
But the difference this time is tighter credit. That has changed the game, we will show when we release out latest household survey results next week. And averages mask the 22% plus falls we are seeing in some places, especially among high-rise apartments. Here some banks are now not lending at all, or only on very much reduced valuations. The AFR reported this week for example that the developers of Brisbane’s 92-storey Skytower, led by AMP Capital and Billbergia, have hired lawyers Norton Rose Fulbright to pressure the valuers to upgrade the new valuations for the apartments which they say are not fair.
The banks’ willingness to lend for apartments has been crimped by APRA caps on lending and the bank royal commission. They are now cracking down on the valuations of newly built apartments where they were once willing to lend.
The AFR also reported that A major bank has a blacklist of 6700 apartment projects across Australia where buyers are refused loans or are offered reduced loan to value ratios (LVR), according to mortgage broker Home Loan Experts.
And PIMCO said this week in a report said that Australian housing prices have fallen for 15 consecutive months. The nationwide all-dwelling price index was down 2.0% year-on-year in August, with Sydney prices down 5.6%. This was Australia’s first nationwide housing price decline in six years. To be sure, prices remain 40% higher than levels in 2012, when abundant credit supply and strong foreign demand began powering the market. But these factors seem set to reverse over the cyclical horizon.
Falling house prices and rising debt-servicing costs lower discretionary income and generate negative wealth effects which may constrain household consumption and therefore prevent the Reserve Bank of Australia (RBA) from hiking its cash rate from 1.5% for some time. This is the basis for our more conservative view of a lower neutral rate and a benign environment for Australian bond yields. We also expect Australian banks to be negatively affected, given their large exposures to the housing sector directly and indirectly. The probability of an agency rating downgrade has risen.
The HIA also reported that total new house sales declined by 2.9 per cent in August, following a fall of a similar magnitude (-3.1 per cent) in July, saying that new home sales, home building approvals, housing finance, dwelling prices, vacant residential land sales and the various relevant sentiment-based indices are all pointing to another year of contracting levels of new home building in 2019. This is consistent with our forecasts which also reflect our expectation that the declines will occur primarily in the eastern seaboard states and be most pronounced in the behemoths of New South Wales and Victoria.
And of course the RBA kept the cash rate on hold this month, as expected, with little change in the narrative, and an expectation that rates will be unchanged for months ahead. But of course the pressure to lift rates will increase as US rates rise, putting more pressure on the Aussie. The question will be whether the RBA will be happy to let the dollar slide and so lift inflation, or lift the cash rate and risk imposing more strain on household budgets. They are completely caught. I still think the next move will be lower, as inflation rises, and momentum in the economy eases. Already the construction sector is in trouble as I discussed with Property Insider Edwin Almedia. You can watch our video show “More From The Property Market Front Line”
The draft report from the Royal Commission got more attention this week, as people worked through the 1,000 pages or so of content. But my initial reaction has not changed this will tighten lending for property further, not least because of the need for banks to be more rigorous in their expense analysis to ensure the loan is “Suitable”. We discussed this in our post “Is HEM dead” and our recent video. The risk of class actions against the banks, rose.
We got a glimpse of the pressures on the banks when the Bank of Queensland released their full year results this week. Their cash earnings after tax were $372 million, down two per cent on FY17. Statutory net profit after tax of $336 million, was down 5%. Being a regional is a tough gig, and they continue to drive significant digital transformation, but despite some accounting wizardry, the cracks are showing in our view. The tighter home lending sector, and reduce fee income both hit home. As a result, capital is weaker than expected. Home lending is under pressure, with this flowing direct to their bottom line. Their shares ended the week at 10.79 down 2% on Friday. On the other hand, regionals Bendigo and Adelaide Bank rose 0.57% to 10.59 and Suncorp rose 0.35% to 14.40.
Among the majors, Westpac was up 0.37% to 27.90, ANZ up 0.40% to 27.72, National Australia Bank down 0.15% to 27.21 and CBA was up 0.11% to 70. AMP, hot hard by the Royal Commission sits at 3.08, up 0.33% on Friday, but way off its April level. The ASX Financials 200 ended the week up 0.36% to 6,040, while the broader ASX 100 was up 0.20% to 5,084. We suspect there is still more downside on the banks, as we discussed in our video with Robbie Barwick “The Vision Thing – How To Reconstruct Our Banking System and “Make Australia Great Again.” You may not agree with all points he makes, but I think the questions posed are really important.
Finally, a reminder that on Tuesday 16th October at 20:00 Sydney we are running our next live stream Q&A event. The reminder is up on YouTube, and you can send me questions before hand, or join in the live chat. So mark your dairies.
And by the way, if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content.
