In most boom phases interest rate rises jump on the back of prices and start weighing them down. But not this time. It begs the question, what’s holding prices back now?
This cycle is unusual. We’re a full year into a boom phase, and interest rates are still on the bench. Glenn’s left them on the sideline for 8 months straight now, and they’ve still got the track-suit on. Makes you wonder if they’re going to get in the game at all.
Normally, when house prices get a strong run on, interest rate hikes are quick to follow. Booms in house prices normally go hand in hand with stronger economic conditions, and the RBA lobs a few rate hikes into the mix just to keep a lid on things.
Take a look at this chart here. This compares house prices with the 3-year bond rate – a kind of foundational interest rate that everything else keys off. This gives you a good snap-shot of how the interest rate / house price relationship normally works.
What we can see is that when house prices start posting strong growth, and especially once they get into double-digits, interest rates start moving up as well.
That’s what normally happens. But not this time around. House prices have the strongest run on in four years, and interest rates are just letting them go. Interest rates are going nowhere, and if you believe the experts AND contrarian bloggers like me, they’re more like to go down than up in the coming year.
Interest rates remain pinned around record lows.
So what’s going on?
Has the RBA missed the housing boom? Not likely. Housing is fundamental to the economy and they’d be very well-aware of the heat coming off that sector of the economy.
So maybe the relationship between the housing market and the rest of the economy has broken down? Maybe this time, house prices are marching to the beat of their own drum, while the economy isn’t marching at all..?
Well, that’s not so easy to answer, but my read is that this cycle isn’t so unusual in that regard. Take a look at this chart here. This tracks house prices and retail spending.
What it shows is that the upward drive in house prices has taken retail spending with it. Why? Because as house prices rise, households feel wealthier and loosen up the purse strings.
And so the surge in house prices feeds into retail spending, which in turn drives the economy forward. The housing boom is good news for the economy, just like it always is.
The RBA may be tempted to take a wait-and-see approach. There are still some mixed signals out there.
Take employment. Things have generally been stronger in recent times, but it’s still patchy. I thought this chart here was interesting. It looks at the employment gains in each of the states over the past six months.
NSW is booming, and QLD is keeping step. But look at Victoria. It hasn’t been a great year so far, and some high-profile plant closures have darkened the mood a bit.
So it’s a mixed bag, and while leading indicators are generally pointing to an improvement, government forecasts see the unemployment rate edging up towards 6¼ percent by the end of next year.
That’s not dire by any means, but it does reflect a bit of uncertainty about the things we can’t control – mostly the Chinese economy and the exchange rate.
And it’s the exchange rate that is the key difference this time around.
The Aussie dollar remains stuck stubbornly above US 90 cents. It’s been inching higher in recent weeks, and there doesn’t appear to be anything pulling it south. Even the budget on Elm Street couldn’t get near it.
The RBA has made no secret of the fact that they’re worried about the Aussie dollar being too high. Glenn’s said several times they’re looking for an exchange rate with an 8 in front of it, preferably towards the lower end of 80 cents.
Because the RBA knows we’ve got a bit of transitioning to do. The mining boom has been driving the economy for a while, and now we need our domestic sectors to fire.
But the high AUD makes that harder than it needs to be. If you’re a manufacturer selling overseas or competing with foreign imports, an elevated AUD makes you less competitive.
It’s an anchor weighing on domestic industry, particularly manufacturing.
And that’s why a lot of people are actually looking for rate cuts. Some industries are begging for it. But interest rates are already at historic lows. It’s not an access to cheap credit that’s holding domestic industry back. It the high AUD.
And lower interest rates would just be more fuel to the fire for the house price boom, and the RBA doesn’t want that getting out of hand.
But at the same time, rates can’t rise either. With interest rates practically zero in much of the developed world, if we push up our own interest rates that will just bring more foreign money pouring into to Aussie assets. That extra demand for our currency will just push the dollar higher.
And it sends a strong signal. “Things are getting so hot here we’re putting up rates.” When every other economy is still limping along, it sends a strong signal that this is where the action is.
And up the exchange rate goes.
And so interest rates remain on the sidelines. And as the end of the second half of the year approaches, it’s not clear that they’ll get a run next quarter, or even the next.
And so for portfolio investors, it’s still a good time to be accumulating. Sydney and Melbourne, and to a lesser extent Brisbane have become seller’s markets, so I’d be casting my eyes a bit further afield.
But it’s not that often the prices are completely off the leash and you can bank on record low interest rates.
Buying conditions like those don’t come around everyday.