To Mods: please don't merge this with other topic as this deep dive will be updated.
UPDATE:
After CPI number was released earlier today, now we know how the Wildcard will play out. Remember that absolute number is almost meaningless, what means most are the first and second derivates - the change and speed of change, and those were spectacular!
A meaningful increase in consumer prices inflation (as expected) should force the rates go much higher and much faster!
Should, however does not mean that the rates will go up (RBA lives in a fantasy land).
If our fearless banker plays his patient card again - stagflation stops being a possibility and becomes a certainty.
The below thesis does not change, the adjustments are on the margin of an extreme demand collapse.
What will happen to house prices if RBA does this or that?
To honestly answer that question, one would need to understand what factors have been driving house prices until now? Commonly mentioned "fundamental" reasons like Immigration, Australia being the best country and Rising wealth are a tailwind but NOT the true reason for these ridiculous prices.
Easy monetary policy = Low interest rates, Quantitative easing with Yield Curve Control are the TRUE reasons. Simple financial math and TINA (There Is No Alternative) behind that – I will explain it below with QE as an example (other methods targeting similar triggers and basically all of them are about creating extra liquidity in the system).
What is QE
QE is not “money printing” despite a common belief. The “money printing” term was first used by Greenspan (who quickly corrected himself) to explain QE and that incorrect label stuck with it. In reality, QE is an “asset swap” when a central bank buys bonds from commercial banks in exchange giving them liabilities in terms of a currency. Central banks do this in a hope that this pile of liquidity will push banks to do productive loans BUT…. Skipping through the technical terms and making it easy to understand – banks CANNOT do much with that pile of money other than siphon it into financial assets.
Since we have only this many assets but RBA can always hit that extra “0” on the keyboard, we quickly found ourselves is BIG troubles with run-away prices on everything “asset” but little to no trickle-down effect to the REAL economy and little CPI inflation. Despite RBA working hard on that keyboard. Hence, there is a serious disconnect between consumer prices inflation and asset prices inflation.
Tend to disagree?
If, however, you are still of the opinion that “Immigration” and “Australian values” are the main drivers of aussie real estate prices, then think again about what happened in 2020. No immigration, soldier boots on “values” and people locked in their homes but the home prices are skyrocketing. What, why?
Reasons are as follows:
* TFF (Term Funding Facility) by RBA who literally printed 200 billion overnight from thin air (remember that keyboard with “0”)
* JobKeeper payment ~100 billion AUD over 2 years
* Business cash flow boost ~32 billion AUD over 2 years
* Coronavirus supplement ~18 billion AUD over 2 years
* Economic support payments ~11 billion AUD over 2 years
* Different kinds of tax benefits, cut-offs, extra claims and write-offs would give you another ~60-70 billion AUD over 2 years
See the proof of figures here (official resource)
https://www.aph.gov.au/About_Parliament/Parliamentary_Depart…
Overall, through extremely loose monetary and fiscal policies, this government has injected close to 400 billion extra dollars into a red-hot economy while maintaining almost zero level interest rates.
As a result, Australia (as many other countries) have financialized the human shelter and will pay dearly for that as a society - one way or another.
Let’s continue, investors like it
Well, this time it might actually be different. In fact, very different because the governments have re-discovered fiscal and central banks have discovered (to their amusement) that QE and rates don’t do any trickle-down into real economy. Who would have thought that levered-up to their eyeballs investors will not only NOT spend but will actually use all of their disposable income to lever-up a bit more? Also that disposal income to debt ratio is not a boring book term but an actual measure of propensity to spend.
So, now we are in the brave new world where we have HIGH inflation and LOW propensity to spend from asset holders. SURPRISE!
Now it comes to options that RBA and governments have at hand to deal with this mess.
—- Part 2 —-
Inflation? So what?
Now, there are only a few of macroeconomic factors that would make money tight other than central banks' rate decision and these are truly "the dark side of the force".
Inflation and negative real wages growth are FAR more potent with much faster effect than any rates rise from a fully impotent RBA and both factors are a kicker for RBA and the woodoo magic that RBA think they have tools to deal with. Well, they have tools, all right. The real question is whether they have the guts to use the tools?
Both factors (Inflation and negative real wages growth) are already happening in full swing and will only accelerate if RBA will not act in a fast and furious manner (not than they are capable of anything like that). Which means that soon those families with 1Mil mortgages on 100K gross income will have to face a choice between paying for food and other necessities OR paying their mortgage. If you studied market events (like bubbles) this is not REALLY a choice and those mortgages will roll IF those families will really have to chose. This is the moment when a bubble pops.
A large and growing number of delinquencies and rushed selling to avoid one will very soon be a much larger destroyer of the proverbial wealth than anything that RBA could pull out of their mothballed hat.
The wealth of nations
Well, one nation, and accumulated from one particular asset class.
We know how that wealth was created don't we? Well, not by working hard, not really. Not by growing the real economy through innovation and smart ways of doing business. Nah, the only thing we do well as a nation is bidding up the dirt. No, I am not judging, just the fact.
"Show me the incentive and I will show you the results". RBA and Federal government tried really hard by pumping 600B into the overheating economy to fund new projects, new ideas, create new businesses… Well, I think they tried… Maybe… Most of those money, however, never reached real economy and being an asset swap or a bank balance transfer was destined to go into assets bubble to blow it out of any sustainable proportions.
There was an article by then acting governor deputy Debelle who basically said "it is up to you (people of Australia) how this economy will develop - as an innovations heaven or as raw materials and dirt supplier". Very nice and touching article from an RBA official saying that the choice is ours.
Well, nah, not really mate. Not after you give 50% GST discount, negative gearing, TFF 0% rate funding and 400B hot potato money. "Show me the incentive and I will show you the results".
Results of incentives: Australian GDP has it's major share in Mining, Construction and Finance sectors (almost 30%) with heavy focus on Consumer (70%).
Most of developed economies are Consumer-oriented but our stand-out dependency on Mining, Construction and Finance as pillars of GDP composition makes that consumer dependent on growth in those sectors because those are major employers in Australia. A vicious circle if you handle it badly and virtuous if do it in a smart way.
What does this have to do with your multi-million dollar hard-asset portfolio? Well, everything - put simply, you cannot build long-term capital gains on top of highly cyclical real economy. Your gains will remain unrealized when the cycle turns and when (not if) the commodities demand will soften, construction boom will fade away and consumer starts feeling the pinch (more like a punch) of inflation. And now we move on to the consumer side - the almighty God of every developed economy.
How the markets really work
In the long-run bull market that is still rising (and most participants are already in long positions), the prices are set by the next marginal buyer who still wants to bid for a higher price. As soon as those marginal buyers are out - the market falls until they appear.
In the bear market that is still falling the prices are set by next marginal seller who is eager to sell at the lower price.
This why our douche-bag genuinely caring government is trying so hard to drive the next marginal buyer in the market with 2% government guarantee deposits, different stimulus schemes like stamp-duty exemption and now NSW douches suggesting the government will "co-buy" (seriously?!) houses.
All this nonsense is to keep the next marginal buyer coming in the market but this is truly appalling and too low now because now they target those people who can least afford to be in financial troubles - single parents, teachers, nurses, low-paid workers who have to get into 30-50 years mortgage prison.
But all these crutches are not holding the top-heavy market anymore. With every housing market price tick higher, we need more and more levered new entrants who will be paying through most of their lives for piece of concrete to live in.
There is no REAL demand for hot property at these unsustainable prices, the next marginal buyer needs to be "stimulated" on one side and left with the sense of FOMO on the other side and to be in a complete state of Buridan's ass to actually take a plunge.
A bit of an off topic. Do you know where else you can trade with 2% deposit? This is 50x leverage and the only other place that will offer you this kind of leverage are forex bucket-shops where 90% of customers lose 90% of their money within the first 90 days (they lovingly call their customers “club 90”). Bucket-shops won’t even put their customers’ orders in the market as they know the customer will always lose. You know why the customer always lose? 50x LEVERAGE and even a small change in the price of an asset (over 2%) will wipe out customers' equity entirely.
Now let's do the 2nd and 3rd level thinking
We know that RBA will NOT be able to pump liquidity and do assets swaps forever. Moreover, they stopped QE already (Dr Lowe has been blessed with some common sense, thanks God) which means that money will become thigh soon.
Furthermore, US Fed has been very clear in their signals and USD will start to come out of the system and not just US, it is now global plumbing that ehy are servicing. With FED becoming tighter and even more tighter in the future and yields spiking, all duration paper has lost its luster.
Those pension funds and other asset managers will start shunning away from the bank bonds yielding too little and the music will stop pretty soon and pretty abrupt.
The liquidity crack party cannot last for too long and if it is not for the RBA's pathetic move or inflation hydra or next depression, then there would be something else that brings this bubble to burst - it is just ready. But is it? And who can stop it from bursting even if it is ready to pop?
——- The Last Part ——
The Grand Fianle
Ok, to the last bit - what is the end game?
I hope you managed to get through the above text and survive because you will need that basic knowledge to make your own judgement.
So, we have 1 wildcard and 3 different ways to respond (let's assume each is a binary option for simplicity).
The wildcard - Inflation
This is truly the unknown but in my view with a huge risk to upside rather than downside. In other words, while my secular view is based on disinflation, the heavy fiscal boot of governments around the world has given cyclical inflation a boost into this year and the next and it will stay unusually elevated for a longer period of time than in previous cycles.
This is bad and this thesis has been already been proven by fall-outs in the most cyclical sector - Construction. 3 major contractors (and who knows how many minors) have folded citing costs, debt and unsustainable business model. High growth on government-supplied steroids has its cost and more bankruptcies will follow. There will be a flow-on effect to connected sectors with more businesses folding and that will lead to higher unemployment and this is where the viscous circle starts. Higher unemployment - lower wages - lower consumer confidence - lower consumption - lower growth - lower earnings - less hiring - even higher unemployment (getting through related sectors). And repeat.
So, when you say "Inflation is not too bad, I will survive, my debts will deflate", all I can respond to that is "Think again". That is why all central banks fear a rising pace of inflation. All except for one - the fearless RBA.
Response #1 - Interest rates
A blunt instrument, takes time to actually start working can have unpredictable results.
UP, DOWN or UNCHANGED
Sounds simple but this is where the "cost of money" is defined, this is fundamental and gravely serious.
As all other "gravely serious" things in Australia, it has been treated in a light-minded and frivolous manner to serve the needs of the next political master. And what political master desires? Get (re-)elected of course! Hence "free money to everybody", "we are rich", "Australian wealth growth reaches orbital levels" and yada yada yada. What could possibly go wrong?
Now we can't even lift off ZERO levels without causing some kind of political trauma.
It is all not so simple of course but think of the interest rates as either targeting economic growth at a cost of higher inflation or taming inflation at a cost of higher unemployment. I won't be able to explain interest rates in one paragraph, there are university courses around this subject, however, if there is one takeaway that is applicable in our situation it is this one - Neutral (natural) rate of interest.
The NRI is a complex concept and has many readings by different economists, however if we agree that Australia is close to full employment with inflation rising fast and we are generous to say that NRI should be Neutral, then the minimum value of the nominal rates should be equal to inflation which is 3.5%. Tomorrow, before lunch if possible.
RBA have been hopelessly behind the curve, and UP is the only way to go.. but…(finish this sentence)
Impact of rising rates on housing
In my view (and contrary to the popular opinion), the impact will be very contained for the following reasons:
- The rates will rise in a slow and steady manner (unless the Ghost of Christmas Past will pay a visit to Dr Lowe and we see a full 350 basis points hike due suddenly increased levels of responsibility at RBA)
- This slow rise will help the struggling families to prepare in a steady fashion and cut on living expenses or sell the overvalued property
- Markets do not drop when the EXPECTED change kicks in, they drop at uncertainty or surprise
Yes, I would expect the property prices to steadily drop anywhere between 10% to 30% depending on location but that is NOT a crash. The other scenario will be much much worse.
Rates do not rise, or RBA drag their feet in rising rates
In this scenario, and if the wildcard inflation keeps rising, we are heading for a stagflationary type of recession - the worst recession of them all.
Watch out for the following events:
- AU PMI to keep posting lower numbers (we are already in a short-term down-trend, so that is kind of expected)
- An UNEXPECTED rise in unemployment
- A SURPRISE rate hike or a hike larger than expected (who would have thought?! )
This is when everything will go cactus, no place to hide and RBA have lost it
High inflation, rising unemployment and lower business activity means failed economy - higher prices drive uncertainty and unemployment -> unemployment means lower wages and lower disposal income -> less consumption in a consumer-oriented economy -> less business activity -> more friction and more product and services shortages -> more uncertainty and more unemployment -> repeat
Are you sure you don’t want that planned and steady rate hike to neutral that has been long overdue?
*Response #2 *- Fiscal
Free Money! A music to electorate ears, who doesn’t like being paid for nothing? Just look at the hype around next year budget – bloody hell, ScoMo’s ratings went up. Well, not in my books.
Fiscal is usually inflationary and must be balanced with either higher rates or higher taxes. It won’t be this time, and this is why I think that the wildcard inflation has a much higher risk to the UPSIDE.
Higher inflation, no rates rise, free money shoveled around – we are doomed!
Just give them a few months.
A housing-related deviation on the Fiscal route (a possibility)
“Buy a house and the government will cover your interest payments for the next 12 months!”, “Invest in 2 properties and get a 3 years tax-exemption for a 3rd one!” – you think this is NOT going to happen?
Well, depending on how desperate it will be. Remember that “next marginal buyer” from How the Markets really work section? This is when they desperately need one (or two).
Just think it through – why would you want to stimulate a sector that has already been growing strongly and “organically”? Usually, you would want to tax the hell out of this nice opportunity, you would not want to over-stimulate it.
I would take it as the last opportunity to sell at high prices, especially if there is an expiry date on that sugar-hit offer. And after cashing out will probably get out of this country for a while – somebody will have to pay for this “free money party” after all.
All other things equal, I would say that extra fiscal is moderately bad for housing as it will push RBA for more aggressive actions (or push inflation higher – pick your poison). Housing-targeted fiscal, in my view, will be a sugar-rush for zombie – the last rushed activity before the inevitable.
The Worst part of fiscal
Remember those “next marginal buyers” in the long-run rising market? Who buy at the top because they think they have nothing to lose, and government gives them a lollipop? Well, usually they will quickly flip and become the “next marginal sellers” in the falling market – willingly or unwillingly.
*Response #3 *- More asset purchases
My view is that we should not see any kind of QE for a longs time as “the wealth effect” has been completely discredited. There is no to very little “trickle down” effect.
The only exception could be the treasury bonds that no money manager would want to touch with a broomstick (speculation and safe-haven run is a different story). RBA will certainly have to jump on this life-time opportunity to buy useless paper with ZERO coupon – sure, it’s not their own money, after all.
If, for some strange (and hopeless) reason, they would need to stimulate asset purchases… Well, I hope that there will be some brave and smart reporter who will put a “promote wealth inequality” label next to “asset purchases” because that's exactly what it is.
Real estate, however, might not and probably will not be in vogue on the next round of QE
Fresh money usually go to a new place with less down-side risk and more upside potential.
I stopped reading there.