In other words, the RBA presents a particular solution (significantly higher rates) to a highly uncertain future problem (inflation expectations), thereby destroying its optionality.
Even one of the RBA’s top executives, Treasury Secretary Steven Kennedy, says there is no real evidence of a wage-driven inflation problem and that most of Australia’s inflation is supply-side.
The concern is that one of the victims of the RBA’s preventive hikes is the hope that Australian workers can finally achieve a 3-4 percent annual wage increase, which is needed to keep inflation lastingly within the RBA’s target.
If the inflation we experience is primarily driven by supply-side factors, as Kennedy claims, attempting to crush it by stifling demand could have damaging long-term consequences for the labor market.
There’s no doubt that keeping inflation expectations under the thumbs with the specter of tight monetary policy is certainly a credit, and that’s exactly what the RBA is doing.
But after promising to raise interest rates only in 2024 — which the RBA has explicitly set in stone by setting an unprecedented target of 0.1 percent yield curve for the 2024 Commonwealth bond — it is reckless to let the economy suddenly with over 200 base to destroy. rate hikes in just four months based on perceived risk that the RBA is not convinced about. (At those 200 basis points, it is assumed that we will get another 25-50 basis points increase next month.)
Luxury real estate hits
Besides consumer demand, of course, another real-time victim is the housing market, which this column has talked about extensively.
I constantly come across realtors who claim how resilient “luxury” real estate is. There are countless stories going around, but the main message is that the top end of the market is “isolated” from the misery experienced in lower-cost sectors.
This is completely at odds with our understanding of how luxury real estate behaves based on the available data. It is typically much more illiquid, pro-cyclical and tends to be more volatile than the mass market. It is also generally much more sensitive to major shifts in the financial markets, meaning it normally leads the lower-cost segments.
Since December 2021, global equities have been wiped out, crypto has lost more than 70 percent of its value, fixed income has suffered record losses and house prices have fallen by double digits year on year. It’s hard to imagine luxury homes being immune to these moves.
A team I founded in 2003 created CoreLogic’s daily “hedonic” home price indices, a world first at the time. Another innovation we developed was a ‘stratified’ version of these benchmarks that divided the housing market into ‘cheap’, ‘average’ and ‘expensive’ areas. More specifically, CoreLogic’s city indices are divided into three subcategories: the cheapest 25 percent of properties; the middle 50 percent; and the most expensive 25 percent.
Looking at the performance of these stratified indices over the past six months, this cycle is no different: luxury homes are once again getting harder and more likely to be smashed than cheaper sectors. In Sydney, the most expensive houses started to fall in value in January, well ahead of the cheapest houses, which only started to fall in April. In Melbourne, luxury homes peaked last November, while the low end of the market held out through May. A similar story is visible in all eight capitals.
CoreLogic’s head of research, Tim Lawless, corroborates this analysis, noting that the most expensive areas underperform lower-priced homes significantly. In Sydney, for example, luxury home values have fallen by 6.3 percent in the past three months, as opposed to the cheapest 25 percent of homes, which have only fallen by 1.7 percent. In Melbourne, expensive homes have lost 4.5 percent in the past quarter, compared to just 1.2 percent for the cheapest homes. And in cities like Adelaide and Perth, where prices have risen over the past three months, the top end of the market has been the worst performer.
Appetite for bonds
The bond market is an area where much higher interest rates are now welcomed (after a painful price adjustment).
Last week, this column discussed NAB’s five-year BBB+ rated Tier 2 bond, which paid 6.44 percent per annum, superior to the franked dividend yield on Australian stocks. NAB printed $1.25 billion of $2.4 billion in investor demand (we bid on $200 million).
The bond has performed strongly since then, as evidenced by the credit spread narrowing by about 31 basis points, pushing the price much higher. This presumably convinced ANZ to capitalize on investors’ appetites for these securities with a comparable five-year Tier 2 bond issue on Wednesday that secured $3 billion in demand, despite a lower yield of 5.9 percent. Once again, the $1.75 billion bond has performed well, with credit spread tightening immediately after the deal that squeezed 17 basis points (we bid at $250 million).
Higher in the capital stock, Westpac Thursday issued an AA-rated, three-year senior bond with an annual yield of 4 percent that quickly yielded $3.7 billion in investor bids (we bid on $100 million). After the issuance, the spread was promptly tightened by some seven basis points.
On the same day, British bank NatWest entered the Australian market with its first-ever bond issuance through a three-year senior ranking of $600 million with an A rating yielding a 5 percent return (we bid on $100 million). This also led to a 17 basis point tightening on the first day. These are big steps for credit markets!
Finally, the Victorian government also stepped in on Thursday by issuing an AA-rated 11-year bond with an annual interest rate of 3.83 percent, which brought in $3.7 billion in bids and was immediately executed. This offered a hefty 68 basis point spread over Commonwealth bonds. Demand from local banks to buy government bonds as liquid assets has been so strong that Victoria has been able to issue $12 billion in debt since the May 3 budget, covering 56 percent of its total $21.3 billion financing requirement by 2023. three is completed. months (i.e. they leave only $9.3 billion to spend).
So the silver lining of much higher interest rates are new opportunities. At the end of 2021, we were extremely negative on our own asset class: in particular credit spreads and interest rate duration risk. With fully franked Australian equities yielding just 6.3 percent, bank bonds with comparable interest rates now seem much more attractive.