Barrenjoey issues its economic outlook – and it’s all a bit grim
Recently, our small-cap team listened to Barrenjoey Capital’s chief economist, Jo Masters, discuss the prospects for the Australian economy. In brief, Masters forecasts the economy to slow rapidly and unemployment to rise to five per cent, with a recession the most probable outcome. She also foresees persistent inflation, which will force the RBA to hold interest rates at the current level until May 2024. If she’s right, investors are in for interesting times ahead.
According to Masters, the Reserve Bank of Australia (RBA), as evidenced by its recent pause on raising interest rates, has become more concerned about a rapid slowdown in consumer spending amid high inflation, rapidly rising rents and higher mortgage repayments.
Today the March quarter Consumer Price Inflation will be released and investors and economists will be paying particular attention to it. But although the RBA needs more time to assess the direction of the economy and the impact of rate rises to date, one more month of data might not be enough to warrant any change in the RBA’s current posture.
One of the burning questions on investors’ minds is whether the RBA resumes raising rates soon or at all. This is not Barrenjoey’s base case.
Masters expects the economy to slow rapidly and unemployment to rise to five per cent, with a recession the most probable outcome. This outlook would be further supported by the next RBA forecast encompassing a downward revision to growth and persistent inflation.
This sticky and persistent inflation, however, will explain why the RBA will not be tempted to cut rates, despite a material slowdown in economic growth. More likely will be the RBA holding rates at the current 3.60 per cent until May 2024.
Admittedly the economic backdrop is complex
Barrenjoey’s base case now is that Australia’s cash rate has reached its terminal rate and will be held here for a prolonged period.
And if pressed to predict which direction the RBA would take if they were to move rates again before the end of the year, Masters believes the probability is higher for a hike than for a cut.
With inflation persistent, and given the time it will take for unemployment to rise, a rate cut may not be possible until May 2024, when inflation is expected to have fallen towards three per cent and unemployment will be at 4.5 per cent on its way to five per cent.
Masters also addressed the impact of the RBA’s rate pause on the housing market
After noting a small house price gain recently, Masters believes housing market prices are reflecting supply factors rather than demand. Supply has been removed quickly and new listings have had their worst start to any year since the GFC.
Predictably, worried about higher rates and falling house prices, vendors don’t list. Consequently, stock available for sale is very weak. Indeed, supply today is about a third of Australia’s 10-year average. The only people listing their homes are those that have to, which includes people moving, divorcing or who have passed away.
When supply declines, turnover follows. Transaction volume is currently down 30 per cent from its peak, which is similar to previous cycles. Transaction volumes tend to fall quickly and by about a third. And this trend tends not to turn until the prospects of the RBA cutting become clear.
That means there is a possibility, turnover falls further from here, which will also keep pressure high on rents, as new investors are prevented from purchasing. As an aside, investors are also under pressure from banks extending less credit for investment as property prices fall.
As a larger than usual cohort of people with fixed-rate mortgages roll onto variable rates, there might be pressure for some of them to sell, which could add to supply. The added supply is also expected to keep a lid on prices.
Masters believes property prices will be flat to slightly up over next few months before a slight decline as supply increases marginally from forced sales.
Overall, however, Masters believes house prices are closer to the bottom.
With respect to buyers, the key constraint has shifted now from and ability to save a deposit to the ability to service a mortgage. A significant increase in serviceability costs is responsible for this shift, which will remain relevant for some time.
As we have often explained here at rogermontgomery.com, access to credit, and by extension, borrowing capacity, is the main driver of house prices over time. Masters concurs – a recent significant fall in borrowing capacity has been a negative for prices but limited supply has also limited the magnitude of declines.
Any increase in supply from here will impact prices negatively, while any lift in prices will be met with more supply. House prices should therefore remain under pressure until the RBA cuts.
Meanwhile, the strong labour market and higher consequent rents will weigh on household budgets, keeping inflation sticky, and limiting the RBA’s ability to cut rates.
So how does impact investors in sharemarkets?
For equity investors, particularly those who own bank shares, it’s worth remembering roughly a third of people own their house outright, a third have a mortgage and a third rent. Roughly 10 per cent of outstanding mortgages, equivalent to $200bn, were written since the pandemic, and within those mortgages, many borrowers have overextended, borrowing up to six times their incomes.
As these mortgages roll from sub-two per cent fixed to up to six per cent variable, it is expected some borrowers will experience significant financial pain. And while many commentators point to the fact some of the pain from recent rate hikes has yet to be passed through to borrowers, intense mortgage competition is an offsetting influence. That competition is of course also a function of flattening demand for mortgages and housing credit, which is also reflected in a sharp decline in new mortgages written. Meanwhile mortgage prepayments have fallen very sharply, reflecting a large number of people actively reducing their mortgage prepayments amid higher rates and living costs.
The tight labour market is expected to persist because Aussie corporates have had a tough time finding labour. The result will be a ‘hoarding’ of staff, reducing their hours as salaries rise rather than just sacking staff. Barrenjoey also noted the effects of higher absenteeism when people are sick, which translates to companies needing deeper pools of staff.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
