• Why is holding cash in the current market valuable? Read my most recent article for the Australian here

Rising rates and a falling dollar put the squeeze on mortgagees

09082018_rates

Rising rates and a falling dollar put the squeeze on mortgagees

For Australians with a mortgage, there’s a good chance life is feeling somewhat tougher – and for good reason.  For one thing, mortgage rates are increasing. Meanwhile, the Aussie dollar has been depreciating against the US dollar, which is eroding the global purchasing power of all Australians.  Unfortunately, these dynamics are largely out of our control.

Let’s look at each in turn.

Mortgage rates

Mortgage rates have been increasing (despite no change in the RBA’s cash rate), thereby increasing the debt-servicing requirements of one of the most indebted household sectors in the world.

It is not the case that Australian banks solely recycle Australian deposits for lending. It is the case that they also borrow abroad – often in the US debt markets – to lend domestically. So it follows, logically, that if interest rates in the US increase, there will be a knock-on effect to interest rates in Australia, all else being equal.

And interest rates in the US are rising – and are expected to continue to rise. Why? Because the US economy is believed to be operating above its capacity. With the 2008 GFC still fresh in the memories of many, it may still be surprising to some that the US unemployment rate is near a 50 year low. Inflation pressures are building. In just two years, the cost of truck freight has increased by nearly 40 per cent, for example. And most of these pressures were present beforePresident Trump signed into law the largest set of changes to the US tax code (read: new fiscal stimulus) in more than three decades.

The Aussie dollar

The depreciating Australian dollar has been primarily driven by strength in the US dollar. In part, this strength is due to the aforementioned rising interest rates. But perversely, this is also likely due to President Trump’s trade policies and potential trade war that may erupt in the coming months.

Why? By levelling tariffs on particular imports, these goods become more expensive for US households to purchase, leaving less income available to consume on other goods. This should reduce aggregate domestic consumption. And assuming production remains at least as strong, then national savings should increase. (Savings in this case should be thought of as: national production, minus national consumption). With more national savings available to fund domestic investment, the US current account should decline (reducing the US trade deficit, which President Trump’s intention), placing upward pressure on the US dollar.

Back to the Australian borrower whose mortgage rates are now going up. It’s hard enough that interest repayments are increasing – and for reasons that are completely out of the control of any Australian policymaker. But housing prices in major cities like Sydney and Melbourne are starting to fall – to the tune of at least 4 per cent per annum. And this is when viewed in Australian dollar terms.

Consider what the prices of Australian homes have done in US dollar terms since just the beginning of the calendar year: they are down by a further five per cent to whatever the change was in Australian dollar terms. This is from the weakening Australian dollar, alone. And this represents a very real erosion of global purchasing power for Australian households – even though this dynamic remains largely invisible in people’s daily lives.

It was the afternoon of November 9, 2016 when news of President Trump’s surprise victory in the US general election was broadcast to Australian shores. For nearly two years, many Australians have believed that this consequential event was of no consequence to them. But for any Australian with a mortgage, funding an Australian-dollar-denominated home: November 9, 2016 was indeed a very important day.

INVEST WITH MONTGOMERY

Andrew Macken is the Chief Investment Officer of the Montaka funds and the Montgomery Global funds. He established MGIM in 2015 in partnership with Montgomery.

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.

Why every investor should read Roger’s book VALUE.ABLE

NOW FOR JUST $49.95

find out more

SUBSCRIBERS RECEIVE 20% OFF WHEN THEY SIGN UP


5 Comments

  1. Hi, Roger

    I realise that there has been some talk about REA which seems plausible given the way the housing market is turning. I guess an interesting company that is comparable is National Storage. If households start selling and downsizing into rentals especially moving into high rises ( which there are plenty of), presumably storage spaces will increasingly come to be demanded – especially ones that are easily accessible.

    john

    in demand?

  2. Carlos Cobelas
    :

    my CBA mortgage rate has not increased.
    still at 3.92% p.a. since Oct 2016.
    that’s about half what I was paying 10 years ago.

    • Thanks Carlos, Any experience that is different to yours, for the marginal buying, will probably still have an impact. Consider the most recent note from our friends at UBS (addended in the above piece):

      Australian Economic Perspectives
      Renovations are just rolling over; as tighter credit & falling home prices see the slump in loans broaden
      Analyst: George Tharenou

      – Tighter credit thesis playing out: home loans drop 8.4% y/y, worst since Apr-16
      Our credit tightening thesis is playing out. The value of home loans (ex refinancing) dropped by 1.2% m/m in Jun-18, to the lowest level since Aug-16; and slid by 8.4% y/y, the largest fall since Apr-16. The weakness is still driven by investors (-2.7% m/m, -18.1% y/y), but owner-occupiers are also showing the first sign of weakness by just turning negative (-0.2% m/m, -0.1% y/y).
      – Lead indicators for renovations suddenly slump; activity about to roll over
      Over the last year credit tightened & home prices fell, but only recently is this negatively spilling over to renovations. A broad retracement in lead indicators of renovations suggest activity is about to roll over. 1) Total (new + established) home sales fell 8-10% y/y to the ~lowest level in 20 years; and 2) declining listings suggest ongoing weakness in sales ahead; 3) owner-occupier loans for alterations & additions slumped ~20% y/y (contrasting the solid up trend in recent years); 4) which suggests further weakness in A&A building approvals, which flipped from a trend of ~+10% y/y in prior months, to -9% in June. However, the negative consumption impact is yet to be seen with household goods volumes still up a strong 3-4% y/y, albeit will likely happen with a lag.
      – Implications: renovations cycle is turning negative as falling house prices bite
      Looking ahead, we still expect credit tightening to see home loans drop 20%, with little chance of a rebound given already record low rates. This will see credit growth ~halve in coming years. But the ‘new news’ is the negative spill over to renovations; with a retracement in approvals, loans & sales. Nominal renovations are 2.0% of GDP, & grew a strong 5-15% y/y during the house price boom years from 2014-2017. But, as house prices slowed, renovations also moderated; & we are making an early & non-consensus call A&A are likely to turn negative ahead. Hence, while new home building approvals have been stronger than expected, total dwelling activity is set to keep falling modestly.

Post your comments