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David Bassanese
Expert
+ About David Bassanese

David Bassanese is one of Australia’s leading economic and financial market analysts, who has authored several investment books and works in a number of advisory roles.

David is Chief Economist at BetaShares, which involves providing economic and investment portfolio advice to both retail and institutional investors. David is also an economic advisor to the National Institute for Economic and Industry Research.

Prior to these roles, David was Economics Commentator with The Australian Financial Review, where is regular “Bassanese” column appeared three times per week, as well as monthly in Smart Investor Magazine.

David’s analysis and commentaries cover local and international economic trends, interest rates, the exchange rate, and share market analysis.

Prior to becoming a Fairfax business columnist in 2003, David spent several years in financial markets as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank. David started his career at the Federal Treasury in Canberra, after which he spent several years as a research economist at the Organisation for Economic Cooperation and Development in Paris, France.

David has authored two e-books: The Australian ETF Guide: cheap and easy investment strategies using exchange traded funds (ETFs), and The Australian Investor’s Guide to Asset Allocation.

David has a first class honours degree in Economics from the University of Adelaide, and a Master in Public Policy from the J.F Kennedy School of Government at Harvard University.

Will rate rises happen soon?

Wednesday, November 22, 2017

By David Bassanese

Slowly but surely, the Reserve Bank appears to be paving the way for a lift in interest rates in the second half of 2018. In an important speech delivered in Sydney overnight, RBA Governor Philip Lowe spelt out in detail why our cherished central bank is feeling more confident about the economic outlook, and more willing to again suggest “it is more likely that the next move in interest rates will be up, rather than down.”

I also share the RBA’s optimism to some degree, but I also suspect its forecasts – or at least its “central scenario” still remains more hope than reality. My central scenario is that economic growth will remain sub-3% over the coming year and wages and inflation are likely to remain stubbornly low.

Under this view, it’s still hard to see the RBA raising rates for a good deal longer.

First the good news. After several years of decline, there is light at the end of the dark tunnel with regard to the slump in mining investment. As the Governor indicated, the “wind-down of mining investment is now all but complete”. Associated with this, economic conditions in the mining states of Western Australia and Queensland appear to have bottomed, with employment rising through much of the past year.

What’s more, there’s also tentative signs of a lift in non-mining investment. This is being supported by an infrastructure boom and ongoing growth in service sectors such as health, education and tourism.

That said, the big drag on growth remains weakness in wages and household income, which in turn has meant consumer spending remains quite soft. Indeed, Lowe was not shy in revealing how hopelessly wrong the RBA has been with regard to consumer spending, as the chart below demonstrates

Undaunted, the RBA’s hope is that the gathering strength in business investment and ongoing growth in employment will eventually lead to a lift in wages growth and consumer spending – a nice positive feedback loop, were it to occur.

And there appear tentative signs that this is happening! According to Lowe “we are hearing reports through our liaison program that in some pockets the stronger demand for workers is starting to push wages up a bit.”

Yes that’s right – wage are rising a “bit”, and in “some” sectors.

While it’s nice to be hopeful, what Lowe did not mention was that housing activity appears to have peaked earlier than the RBA expected – and this handy source of growth and employment will go missing in action in 2018. Consumer spending in Sydney and Melbourne is also increasingly vulnerable as house prices eventually turn. Recent auction clearance rates already suggest Sydney house prices are now falling.

And as the RBA also readily admits, there also remains considerable spare capacity in the overall labour market – and, as most evident in the United States, wage growth still remains dormant in countries with labour markets much tighter than our own.

While business might respond to some pockets of labour tightness by bidding up wages, there’s also a good chance they’ll react by focusing on improved productivity through labour saving investments instead. After all, companies face intense pricing pressure also, and Amazon’s attack on local business is only just getting started.

Of course, while cost cutting – due to both competitive imperatives and technological opportunities - makes sense for an individual firm, at the national level it can become self-defeating if to leads to weak household income and consumer spending (and more broadly rising income inequality).

This is the quandary Australia and much of the world now faces, and it’s why there’s a growing dichotomy between business and consumer sentiment.

For investors at least, the good news is that persistent low inflation and low interest rates means every dollar that a business is able to earn is cherished more highly – which is why share market valuations are likely to continue to push higher for some time yet. But for those getting excited about a rate rise sometime soon – I would not hold my breath.

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Is the ASX overvalued? It’s all in the numbers

Wednesday, November 08, 2017

By David Bassanese
 
Just when local investors could be forgiven in thinking all hope was lost, the Australian S&P/ASX 200 share market index has made a feisty lunge to 6,000 points in recent weeks.  It naturally raises the question, can these share market gains be sustained and could the market keep moving higher?

I think it can, but don’t expect runaway gains. And I still suspect our market is likely to underperform our global peers – especially technology heavy indices such as America’s NASDAQ-100 Index.

Of course, some have been quick to point out that the local market’s valuation is now elevated and we don’t have much earnings support underpinning recent gains.

As regards valuations, I’ve got news for them – most markets around the world are trading at “above average” price to earnings ratios. We are not alone.  But comparing current PE levels to history is a little misleading if the fact that global interest rates also remain well below average is ignored.

It’s like saying Australian house prices are overvalued because today’s rental yields are lower than average – but this is to be expected given the structural decline in interest rates over recent decades. The yield return on competing assets – such as term deposits and corporate bonds – has declined, so the yield on both property and shares must also decline. And the way that’s achieved is by pushing up valuations relatively to underlying earnings and rents.

Let’s put some flesh on the bones with some real numbers.  According to my estimates, with the S&P/ASX 200 trading at around 6000 points, it’s consistent with trading on a price-to-forward earnings ratio of 16.2.  Its longer-run average (which I estimate since 2003) is around 14.

So far so bad. It implies the market is 11% “overvalued”.

But today’s yield on Australian Government 10-year bonds is around 2.6%.  Its long-run average is around 4.5%, or a full 2 percentage points less.  That has to be of some relevance to the market.

In fact, if we invert the PE ratio we get what’s called the equity market’s “forward earnings yield”, which is now just around 6.2%. Subtract the 10-year bond yield of 2.6% and we get what’s called the equity premium of 3.6%.

This premium’s long-run average (i.e. since around 2003) has been 2.5% - so the premium remains higher than its long-run average. On that basis alone, it’s hard to argue the market is overvalued.

That said, if we examine even longer-run history we find the market’s equity premium has not tended to be constant over time – rather it has been higher when bond yields have been low and lower when bonds yields are high. In a sense, equity valuations don’t tend to fully adjust to reflect very low and very high bond yields – as the market suspects this level of yields is not sustainable.

As seen in the chart below, my own long-run calculations (based on patched-together estimates of earnings and valuations stretching back to the early 1970s) suggest the market is today reasonably close to fair-value.  With bond yields around 2.5% or so, a PE level of around 16 seems reasonable.

Of course, that does mean should bond yields rise from here, it should place downward pressure on equity valuations. But provided the rise in bond yields is fairly modest (which seems most likely given persistent low inflation), the downward pressure on valuations should not be too great.

By my estimates, a lift in 10-year bonds yields to 3% and 3.5% would push PE fair value down to 15.8 and 15.4 respectively – or lower prices by around 2 to 5%. Note yields at this level would still be consistent with a PE ratio that remains comfortably above its recent long-run average of 14.

And offsetting this of course should be at least a modest lift in corporate earnings, which have been sluggish for some time – plus a not to be forgotten 4% gain from dividends (plus franking credits).

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Bitcoin - is this time different?

Wednesday, October 25, 2017

By David Bassanese

As an analyst of global financial markets, it is getting increasingly hard to ignore what was once just a plaything among computer geeks – the rise of so-called crypto-currencies such as Bitcoin.

Having witnessed the rise and rise in the price of Bitcoin, and the growing chatter about its rising status in the popular press, humble analysts such as myself have been forced to confront it and decide - is it worth the hype, or is it yet another in the long line of financial bubbles?

I’m no computer expert, but I am a student of economic history. And, as I explained to Paul Rickard on the Switzer show earlier this week, if it looks like a duck and walks like a duck – chances are it’s a duck.

By that I mean the parabolic price gains for Bitcoin in recent months – and its rising popular interest – bear all the hallmarks of classic bubble. Of course, interest in Bitcoin only recently appears to have made the transition from first-mover computer geeks to the general public, so that probably means explosive price growth could last another year or so.

I can’t say when the price of Bitcoin will collapse – it could yet double and triple in value before then – but history strongly suggests collapse it likely will.

BitCoin Price in $US


Source: CoinDesk.Com

Of course, many of those buying Bitcoin today also probably expect prices to fall eventually. All they know is that prices are rising, and momentum likely means prices will rise further still. Another name for this is the greater fool theory – I’ll buy now irrespective of price, because I believe there’ll be a bigger fool that will pay even higher prices later.

Why am I a sceptic? As the believers like to point out, the supply of Bitcoin is apparently limited.

There’s now 16 million units, and supply is growing by only a few percent per year, and will be ultimately capped at 21 million units. Even at a price of $US6000, the total market value of Bitcoins outstanding is only around $US100 billion, which is still a fraction of the US money supply – much less that of the global economy as a whole.

At the same time, legitimate transactional demand for crypto-currencies is apparently high and rising. One central rational is that, unlike with national currencies run by governments and complicit central banks, there’s apparently less risk of monetary debasement though the printing press. It’s also seen as relatively cheap and easy to make international payments than with global currencies, and transactions can be made with greater anonymity (which is apparently a social good?).

But all bubbles start with some fundamentals behind then. And as with the internet itself, the deregulated blockchain technology that keeps account of crypto-currency transactions will likely become a fundamental part of the economy of the future.

That said, whether we actually need competing crypto-currencies to take the place of fiat currencies is highly questionable. After all, there’s now enough evidence to suggest modern democratically elected governments don’t easily seek to debase their currencies – indeed, inflation remains stubbornly low across the globe. International electronic transactions using traditional credit cards and national currencies are getting easier and cheaper by the day. I also I retain a lot more confidence that the $US and the $A will remain at least as widely acceptable as a means of payment and retain their store of value (i.e. won’t depreciate up to the usual 90% seen in the aftermath of bubbles).

As we’ve seen in China, it also seems likely governments will eventually crack down on allowing crypto-currency transactions if its leads to concerns over monetary stability, tax avoidance and/or terrorism funding. And it’s hard to believe many of these so-called currencies won’t be subject to massive cyber attack.

But the death knell to the crypto-currency craze will be supply – which is what eventually kills most financial bubbles. America built too many houses during its housing bubble, and launched too many dotcom companies during its dotcom bubble. The Dutch grew too many tulips.

In this regard, I’d be dubious about claims of fixed crypto-currency supply – especially as Bitcoin (apparently decentralised power structure) already itself appears to be creating a number of offshoots, such as Bitcoin Cash and soon even Bitcoin Gold. Apart from Bitcoin, moreover, there’s now a multitude of alternative crypto-currencies vying for attention, such as Ethereum.

My message: enjoy the ride while it lasts, but don’t say you weren’t warned when the mania eventually ends. This time is never different.

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Households and business in tug-of-war over economy

Wednesday, October 11, 2017

By David Bassanese

The Australian economy is engaged in a tug-of-war between households and business. Households are in a funk, while business remains resolutely upbeat.

Euphemistically, it’s what economists call a “mixed” economic outlook.

Another popular phrase is that the data are “conflicting”.

In turn, that’s left a few of the nation’s financial market economists thinking the next move in interest rates will be up, whereas others (including myself) can’t see the Reserve Bank moving one way or another for at least another year. There’s still even a chance the RBA could eventually cut rates again.

Just witness what we’ve seen in the space of a few short days.

Last week we got a retail sales “shocker”, which revealed spending at our malls and shopping strips dropped 0.6% in August after a (downwardly revised) 0.2% decline in July. Of course current September quarter weakness follows a spike in sales in the June quarter, which now appears to have reflected post-flood re-stocking in Queensland. Overall, retail spending can best be described as choppy around a fairly weak underlying trend.

Soft retail spending is certainly consistent with other trends in the economy – such as weak wages growth, high household debt, and the recent squeeze in real incomes caused by a further spike in electricity prices.

It’s also consistent with the weakness in the retail sector seen in National Australia Bank’s monthly business survey.

But here’s where the differences emerge. The NAB survey released yesterday showed overall business conditions in September remained at robust above-average levels. According to corporate Australia, overall trading conditions are doing nicely, and businesses still intend hiring many more workers in the months ahead and are slowly but surely lifting non-mining capital spending plans also.
 

In turn, corporate optimism is consistent with what can only be described as boom conditions in the labour market. Net new jobs surged by 54,000 in August, and by 2.7% over the year – even though the unemployment rate still remains stuck around the mid-5% level.

So even though consumer spending and household sentiment is at best patchy, corporate Australia is pretty happy and still keen to take on workers.

Why is this so? And will downtrodden consumers drag business down or upbeat corporations drag hapless households up?

Looking through a range of other indicators, including the NAB survey, several positive business trends are apparent.

For starters, we are still enjoying a strong housing construction boom, together with a public infrastructure boom, both of which are also having nice downstream effects on the manufacturing sector. Strong Sydney and Melbourne property sales are also keeping real estate agents and lawyers very happy. The LNG gas and coal/iron-ore export shipping booms are also continuing, which is still holding up jobs and keeping the transport sector happy (though gas exports are arguably contributing to high electricity prices at home). In services, our increasingly revenue hungry universities are taking on more students in droves, even if the quality and cost of education is consequently suffering. For demographic reasons, the health care sector continues to boom also – as is spending on mobile phones and broadband services.

In short, there are a lot of positive drivers in the economy – which is being reflected in overall still positive levels of business conditions and employment. That said, many important traditional industries from retailing to media are facing the blowtorch of competition. More generally, average workers are still struggling to get a decent wage increase, and still feel their employment situation is vulnerable. Consumer spending (particularly traditional “bricks and mortar” retail spending) is understandably therefore dragging the chain.

The good news is that many of these positive forces – like infrastructure, exports, education and health - are likely to continue well into next year. However, the housing construction boom does appear close to a peak and will head into reverse in 2018. And households in Sydney and Melbourne will be feeling even less upbeat once signs of flatter house prices emerge. Traditional retail and media companies also face ongoing structural challenges – especially from upstart dotcom darlings that don’t hire many and shovel most of their profits offshore.

My overall sense is that this means the tug-of-war taking place across the economy will continue – a case of two steps forward and two steps back. In turn, this will frustrate the RBA’s hopes of 3% growth emerging in 2018 and will likely mean interest rates won’t budge either way for some time to come.

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America’s economic expansion could just keep going

Wednesday, September 27, 2017

By David Bassanese
 
Could America be set to enjoy one of its longest economic expansions on record?

Maybe, just maybe.  Let me tell you why.

For starters, there has been a notable lift in global economic momentum since around mid-2016, after global growth downgrades through 2014 and 2015.

Why the turnaround?

We can point to a few factors. For starters, a belated tightening in OPEC oil production opened the door for renewed US investment in the energy sector (which has kept global oil prices frustratingly low for all producers).  As part of its latest Five Year Plan in late-2015, China also flicked the switch back toward growth-orientated policies, which saw infrastructure and housing related construction rebound – in turn fuelling the 2016 surge back in iron-ore prices.

More generally, low energy prices are supporting consumer spending across the US, Europe and Japan, as is reduced drag from earlier fiscal belt tightening.

Last, but not least, the hopes of greater US fiscal stimulus under US President Trump – together with less regulation - has likely sparked a greater degree of “animal spirits” among the global business community.

So far so good, but can it last?  Here’s where developments get even more encouraging.

It is common for investors to think that long economic expansions – such as the global economy is enjoying at present – tend to die of old age.  After all, all expansions eventually end in a downturn – so the longer an expansion continues, the higher apparent probability that a slump could be just around the corner. Rising levels of debt could be one such catalyst, as might a rise in wage and price inflation and labour markets tightening.

That said, there are some promising signs that the present global recovery could continue for a while longer – and may even enjoy a second wind.

The grounds for such optimism were contained within an interesting recent speech by Reserve Bank Assistant Governor (Economic) Luci Ellis.

Note America’s present economic expansion is now around 80 months – which is relatively long by historical standards.  Yet despite this longevity, Ellis points to research from the US Federal Reserve which indicates that the length of US expansions since World War Two have varied widely, and even though the current expansion is above average, there are three expansions that have been even longer.
 

In short, over a period of at least the first 10 years, history suggests the probability of a US expansion ending anytime soon does not appear overly affected by its current age.

A further encouraging feature noted by Ellis is that, while in some counties – such as China – leverage has increased notably, this has not been a global-wide phenomenon.  We’ve certainly not – as yet - seen the global build-up in leverage evident prior to the 2007-08 financial crisis.

And lastly, while labour markets have tightened in many countries, the next leg of growth could come from a lift in business investment, as companies try to overcome growing labour shortages by belatedly boosting still-weak levels of productivity.   As Ellis notes, “productivity itself can be cyclical..it's not clear [current weak levels of productivity growth] ..will continue once spare capacity in these economies has been fully absorbed.” Tentative signs of this are becoming evident with a lift in business investment across several regions.


Indeed, there’s a risk we could be living through a re-run of the 1990s – which saw the longest US post-war expansion on record (10 years).  Ellis notes that the 1990s was in fact similar to today in that that “considerable innovation seemed to be happening, but this took a while to be evident in the productivity data. This is because firms take a long time to adapt their business models and processes to the new technologies.”

How delicious a prospect would it be for America’s current economic expansion to last at least as long as that of the 1990s?  If it could, we’d be set to enjoy at least another three years of decent global growth and likely rising equity markets.

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Don't lose faith in global equity markets

Monday, September 18, 2017

By David Bassanese

Having spent the past week travelling the country on an ASX Investors Road Show, I thought I’d share with you a few of the key takeaways from my presentation.
 
The bottom line is that I remain cautiously bullish on the global economic outlook, and hence global equity markets. Globally, we are enjoying both an increasingly broad-based or “synchronised” upturn, with Europe, Japan and several emerging markets picking up over the past year to join the longer established US economic recovery. Fears political populism and an EU-breakup are receding in Europe, and even the long-touted Trump fiscal stimulus has so far not been needed.  
 
What’s more, it’s what might be termed a “Goldilocks” global economy, with growth neither too hot to cause undue inflation and higher interest rates, but also not too cold to push up unemployment and crush corporate earnings. Importantly, with inflation still generally low across the world, central banks generally remain very reluctant to withdraw their punch bowls quickly.
 
Low inflation and accommodative central banks mean that global bond yields remain very low. Indeed, the Bloomberg Global Aggregate Bond Index retains a yield-to-maturity of only around 1.5%.
 
Against this backdrop, while global equity price-to-earnings (PE) valuations are modestly above average, this seems easily justified for now given the rich valuations in the bond market. What’s more, global equity markets are also being underpinned by good gains in corporate earnings – helped by improvements in sales activity (consumer spending and business investment) and very tight control of costs. Both European and Japanese corporations are also showing a determination to match US rivals in terms of return on equity.  
 
So far so good. The bad news for Australian investors, however, is that patchy earning performance continues to hold back the local market. While resource companies have produced decent earnings growth of late, thanks to a rebound in iron-ore prices (the sustainability of which is doubtful), we especially lack the tech darlings that are lighting up global markets. From a market or industry sector perspective, Australia remains a good place to source income opportunities, but it’s a case of “go global for growth”. Thankfully, seeking out global growth sectors (like technology, health care or agribusiness) has never been easier for Australian investors thanks to the advent of exchange traded funds (ETFs) which can be bought and sold on the ASX just as easily as a company share.
 
Of course, there are risks. The US labour market is tightening, and a pick-up in wages and/or price inflation might still be just around the corner. If so, the Fed will tighten policy more aggressively, which could spell the end of the current 8-year global bull market. That said, price and wage pressure remains quite low in the US, and there are strong structural reason why this might remain the case.
 
Another obvious risk factor is North Korea. But get this: it may surprise some investors to know that the South Korean Benchmark equity index, the KOSPI 200, is up 20% so far this year. Since the current troubles with North Korea started a few months ago, the Korean market has pulled back by only 2.5%.
 
If even the South Koreans - who would be ground zero in the event of a war - aren’t worrying about North Korea too much, it suggests we might take a measure of comfort also. I guess baring widespread nuclear annihilation (which is not worth insuring against anyway!), the North Korean stand-off seems more likely to end in either a diplomatic solution or regime change though a relatively quick and decisive US assault.

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ABC's Four Corners misses the real story on dodgy lending practices

Wednesday, August 30, 2017

By David Bassanese

Don’t get me wrong: I think the ABC public broadcaster is one of Australia’s most treasured public institutions. And the long-running Four Corners program often does a tremendous public service in regularly exposing cases of public or private business misbehaviour.

That said, the premise of a recently aired Four Corners program - that Australian house prices and household debt are dangerously high and this has been largely caused by dodgy home lending – is simply wrong.

Worse, the story glided past a real public policy issue that it could have explored in more detail.

Of course, the Four Corners premise is a great story angle as it fits so neatly with what happened in the United States – and parts of Europe – more than a decade ago and led eventually to the global financial crisis. And sure enough, it’s always possible to find a few hard luck stories or cases of extreme greed and ignorance.

But it’s a big stretch to claim poor lending has driven up Australian house prices alone, and that the economy and banks are dangerously over extended.

Not mentioned in the program were the role of super low interest rates, strong immigration, restricted Sydney supply due to inner-city development constraints and poor transport links to more affordable regional areas, and the boom-bust mining cycle that did lead to regionally specific housing bubbles in certain parts of Western Australia and Queensland.

Unlike in the United States, Ireland and Spain moreover, Australia overall has not been swamped by housing supply in response to high prices in a way that would force prices down. Unlike in the US, moreover, our mortgage lending is recourse – meaning banks can come after any other assets you might own if you default on your mortgage. Indeed, even in Perth where property prices and employment have slumped in recent years, default rates are hardly catastrophic.

The great pity of the Four Corners program is that it tried to portray dodgy lending practises as the cause of a nationwide housing bubble - i.e. a macro-economic problem – and missed the real story that it’s nonetheless still a serious micro-economic problem that hurts the most financially vulnerable and gullible in our community.

Indeed, in one of the major cases in the Four Corners report, one lady nearing retirement claimed she was goaded into buying an investment property by a telephone sales pitch. She also claimed she provided no information regarding her income on the broker-completed mortgage application which was eventually accepted by the ANZ Bank.

It begs the question: was the loan document falsified or not, and does the ANZ – and other banks for that matter - simply take such provided information on faith or do its own checking? On camera, ANZ CEO Shayne Elliott claimed the bank does a “thorough due diligence on [borrowers] ability to repay their loan.” How thorough – are the income statements verified with the borrower or not?

Following the glare of Four Corners publicity, the ANZ Bank appears to have reached a compromise settlement with the lady in question. Four Corners in turn noted on air that “the Bank conceded [she] was targeted by aggressive sales tactics by the broker and developer.” We were then invited to read ANZ’s full statement on the Four Corners website.

But although curiously not mentioned on air, this statement included the startling fact that ANZ “had written to her advising she was overpaying for her investment”. That’s nice of the bank, but it still went ahead and lent her the money!

ANZ also claimed she “also acknowledged that she was responsible for declaring her estimated expenses and advising ANZ her financial position was not likely to change in the near future.” I could be wrong, but this suggests the ANZ does not independently verify the financial data on applications submitted by brokers. ANZ also had to explain to her that it was not their job to “provide her advice on her investment plans.”

This is the real story that Four Corners glided past. Even though the conflicts associated with financial product commissions have been largely eliminated, compliance burdens continue to make sorely needed financial planning services so expensive in Australia that only 25% of households seek it out – the rest are left to fend for themselves and often end up victims in the less regulated property sector.

The bad news is that this can lead to immense grief for the overly greedy or gullible. The good news at least, and contrary to what Four Corners claim, these investors still seem rare enough that they have not placed the whole economy – or more specifically the banking sector – in peril.

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Fear not over-indebted households - there's safety in numbers

Wednesday, August 16, 2017

By David Bassanese

Fear not over-indebted Australian households – having debt has its problems, but also its advantages.  

Rightly or wrongly, Australian households are finding this out right now given the Reserve Bank’s caution about lifting interest rates anytime soon.  

There’s safety in numbers - big numbers. 

Indeed, it was John Paul Getty who once quipped that if you owe the bank a $100 that’s your problem, but if you owe the bank $100 million then it’s the bank’s problem. 

Famed Australian entrepreneur Alan Bond lived by the same motto, figuring he had great bargaining power over the banks given he tended to owe them a lot of money. And even the great Wall Street banks such as Goldman Sachs and JP Morgan were granted protection during the global financial crisis, because the sheer size of their operations and debt levels meant they were simply too big to fail.

In this sense, the Australian household sector is also too big to fail – and the RBA knows it. 

Indeed, consumer spending accounts for around 50 to 60% of economic growth and so were households to suddenly decide to close their wallets and focus on paying down debt it would send the economy into a spin, and make paying down those debts all the harder.

Thanks to low interest rates and the current housing boom across the east coast of Australia, the ratio of household-debt-to-disposable income has ratcheted up since 2012 from around 170% to 190%. By global standards, this ratio is relatively high – at least compared to larger economies such as the United States, Germany and Japan. But it’s not too far out of line with debt levels in Canada, New Zealand and several Scandinavian countries.  

Either way, the debt load - along with weak growth in wages and perceived employment vulnerability - has left consumers with new found caution. Consumer confidence remains decidedly less upbeat than business confidence and overall household spending in the past year or so has been patchy. 

The good news for indebted households – though not for those reliant on interest income – is that their debt vulnerability has not gone unnoticed at the RBA. 

In the minutes to its July policy meeting released this week, for example, the RBA Board noted that “the high level of debt on household balance sheets raised the possibility that consumption growth could be lower than forecast”. What’s more, it was also noted that “the need to balance the risks associated with high household debt in a low-inflation environment” was also influencing the Bank’s decision to leave interest rates on hold – even though a range of economic indicators had improved of late.

It’s been this vulnerability that has also encouraged the RBA – along with the Australian Prudential Regulation Authority (APRA) - to introduce a new range of so-called “macro-prudential” controls to better target the problem areas of speculative property borrowing without hurting everyone with a mortgage. The net effect has been that interest rates faced by property investors, and especially the vast bulk of those with interest-only loans, have increased by around 40 basis points so far this year – almost two full RBA rate rises. Meanwhile, the mortgage rate for existing owner occupiers with traditional principal and interest loans have hardly changed. 

Although the housing markets in both Sydney and Melbourne remain hotter than officials ideally desire, it’s fair to say the introduction of better targeted policy measures has been a welcome innovation and has left policy-makers with far greater flexibility to manage both inflation and financial stability.

Accordingly, until such time as inflation rises more strongly and/or the economy gets a greater head of steam, don’t expect the RBA to use the blunt instrument of official interest rates changes to tackle lingering strength in our hot Sydney and Melbourne property markets. If push comes to shove, it seems more likely that APRA will impose even tough restrictions on investor lending, possibly even quarantined to activity in our hottest cities.   

As I said earlier, many households have high levels of debt – but there’s safety in numbers. 

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Should we consider more drastic measures for a lower dollar?

Wednesday, August 02, 2017

By David Bassanese

The bad news for the Australian economy and local corporate earnings is that the Australian dollar remains strong - even though the Reserve Bank has done what it can to douse speculation that it was contemplating a hike in interest rates sometime soon.

That may mean we might need to eventually consider more drastic measures to keep the $A competitive – such as some form of tax on hot money flows into the country. After all, we have already party re-regulated the financial sector through new “macro-prudential” controls, which have given policy makers extra flexibility to manage the housing sector without resorting to across-the-board interest rates changes. Some new tools might also be needed to deal with the $A.

As I predicted in my last Switzer Daily column, both Deputy RBA Governor Guy Debelle and Governor Phil Lowe went out of their way in recent weeks to explain that recent references to the “neutral” RBA cash rate now being around 3.5% were not meant to indicate the RBA thought rates remained too low (at 1.5%) and needed to be lifted quickly.  

Near-term rate hike expectations have eased accordingly. Yet, the Australian dollar remains stubbornly close to US80c. As the RBA noted in its post-meeting statement this week, however, a large factor behind the $A’s apparent strength is broad-based weakness in the US dollar. Since the start of the year, for example, the $A is up around 10% against the US dollar, but it’s down slightly against the Euro and up only 5% against the Japanese yen.

The US dollar globally remains unloved – due to both diminished hopes of US fiscal stimulus from the increasingly dysfunctional Trump Presidency, but also because expectations of monetary tightening in other economies (notably Europe, but not Japan) have lifted relative to those in the United States.

All this leaves the RBA in a desperate bind. It can’t cut interest rates to help lower the $A as this would only add fuel to the speculative fire still heating up Sydney and Melbourne house prices. And it is now even less likely to consider a “shot across the bows” lift in rates to prick the bubble in speculative sentiment in these hot markets, lest this send the $A catapulting even higher and crush business confidence in the process. 

Policy makers are tackling these twin problems through other instruments. Macro-prudential controls – such as demanding banks cut back on home lending – are trying to dampen hot house prices, and APRA may need to do more in the weeks ahead if there’s not greater evidence of a cooling in the property mania.

As for the $A, the only other instrument available at this stage is RBA “jawboning.” In its policy statement this week, the RBA did acknowledge that a higher Australian dollar posed downside risks to the economy, but the jawboning was not particularly strong, which does seem a little surprising and disappointing.

That said, I also sense the RBA is cautious about trying to jawbone too much, as it fears this might have only a temporary effect, if any at all. Failed jawboning might expose that the Emperor has few clothes. 

Complicating matters further, to a degree a somewhat firmer $A also seems justified, given the continued strength in iron ore prices – which in part, seems fundamentally based given the ongoing strength in Chinese steel production, but also part speculative as iron ore futures have become a plaything for Chinese retail investors.  However, the relative contribution of fundamentals and speculation to short-term moves in the iron ore price is difficult to untangle, which also makes it unclear how much of the $A’s broad strength seems justified and is likely to last.

What to do? We can hope that the US dollar begins to strengthen again – and that is certainly possible if US inflation does rebound and the Fed reaffirms its tightening bias. Who knows, even Donald Trump might finally focus on tax cuts and infrastructure spending and succeed in getting a fiscal stimulus package through the Congress (but I won’t hold my breath). Iron ore prices might also fall back if China eases back on stimulus and/or speculative fervour wanes.

But a growing risk is that the $A could remain uncomfortably high for a while – especially if the Fed goes soft on raising US rates.  

How concerned the RBA becomes will ultimately depend what effect this begins to have on the economy – in particular, whether it leads to a collapse in the currently high levels of business sentiment. 

If all this comes to pass, it’ll mean Australia is once again on the losing end of the global currency wars. If a hot housing market stops us from cutting rates to deal with the strong $A, that may mean other instruments might need to be considered.  

It’s a possibly radical thought – but so was re-imposition of bank lending restrictions only a few years ago.   

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Is the soaring Aussie dollar just an overreaction to recent events?

Wednesday, July 19, 2017

By David Bassanese

The Australian dollar is a sell at current levels, and currency-unhedged global stocks are now even more enticing for local investors. 

A few factors have conspired over the past week to push the Australian dollar to the top end of its multi-year range. Indeed, the $A now looks tantalisingly close to touching US80c, and economists – as usual in times of market excitement - are outbidding each other to predict just how far can it go. 

But to my mind, the $A’s move seems an overreaction to recent events and traders are also underplaying how dismayed the Reserve Bank is likely to be over its recent strength – making it even less likely it will hike local interest rates anytime soon. 

The first overreaction seems to have been to recent commentary from the US Federal Reserve chair, Janet Yellen. In her testimony last week, she suggested that America’s so called “neutral” interest rate is “currently quite low by historical standards” and so “the federal funds rate would not have to rise all that much further to get to a neutral stance”. The neutral rate is usually defined as that which would neither overly stimulate, or hurt the economy.  

That said, Yellen also indicated that she expected the neutral rate to rise in coming years as the economy improved, meaning “additional gradual rate hikes are likely to be appropriate over the next few years.” In other words, the neutral rate – at least on this definition - is not fixed in stone and can move in line with developments in the economy. Indeed, the Fed’s medium-term fed funds projections still has it settling at around 3% over the next few years, compared with only around 1 to 1.25% today.

Frankly, Yellen’s decision to discuss the neutral rate in this way was clumsy and seems to have more confused than informed the market. 

What also excited the market, however, was Yellen’s acknowledgement that inflation has surprised on the downside in recent months, and hint that if this persisted – which she does not expect - it could affect the Fed’s desire to lift interest rates going forward. 

This is a potentially more serious threat to the outlook for higher US interest rates – as there is indeed a good chance, I think, that US inflation will hold stubbornly below the Fed’s preferred 2% target. History alone suggests as much. 

But the risk for the Fed, in this case, will be a potentially explosive further upward move in equity prices and decline in bond yields – which would create the risk of creating destabilising financial bubbles down the track. I think provided the economy keeps churning out good employment growth – as I expect - the Fed will still be of a view to continue tightening gradually, even if US consumer price inflation hovers somewhere between 1.5% and 2%. 

That means a rate hike in December still seems more likely than not, and moves to start running down the Fed’s huge accumulated bond holdings by September.

Meanwhile, adding to the local confusion were the minutes from the Reserve Bank’s June policy meeting released yesterday. In the minutes, the RBA felt the need to discuss our own neutral interest rate, and suggested it was now somewhat lower than before the financial crisis – around 3% rather than 5%. One interpretation of this statement would have been – as alluded to in America by Yellen – is that interest rates don’t need to rise as much to get to neutral. But the local market took instead took this as a hint that the RBA was keen to raise rates as they were still well below neutral. Again, I think this an overreaction. 

What’s more, I’d note that the RBA’s June policy meeting – to which the minutes referred – came before Yellen’s dovish speech last week and the strong bounce in the $A. I think the RBA would be even more reticent to hint at higher local interest rates now, and I suspect it might reveal a more dovish tone in important speeches by Deputy Governor Debelle on Friday and Governor Lowe next week.

All that said, if the Fed does decide to go on hold due to persistently low inflation, it’s very hard to see the RBA hiking rates anytime soon – and it could still cut rates – given the obvious upward pressures on the $A otherwise.

All that points in the direction of the $A holding its recent range, even if the Fed turns a lot more dovish. The same can’t be said for equities or bond yields, however, which would both shoot up and down respectively.   

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