Boom or bust? Rate hike shock rocks the property market

Thursday, 9 June 2022 — Albert Park

[6 min read]

Dear Reader,

The news caused more of a flurry than the election result — a 0.5% hike in the cash rate!

The last time the RBA raised rates by 0.5% was 22 years ago.

Admittedly, I didn’t expect such a jump.

But clearly the RBA is out there to try and shock the market into submission.

Language warning of further rate rises is sending the wind up recent homebuyers.

I’m talking about those that took on whopping great mortgages over the last couple of years.

A significant proportion of first-time buyers — a generation if you like — entering the market has never experienced a rate rise. The 0.25 increase at the recent RBA meeting was the first for 11 years!

How quickly things have changed for this demographic.

I expect a few punters will start blaming the banks for lending to the unsuspecting innocents.

Their stories of impending ‘mortgage stress’ are now clickbait for the MSM.

Regardless, the serviceability buffer rate — which was increased in 2021 — gave some constraint to overextending. And notably, existing owners are well ahead in their repayments.

Needless to say, the media is now back to forecasting an impending ‘housing crash’.

Melbourne and Sydney, the biggest capitals by population, have already slowed considerably from where they were this time last year.

The preliminary clearance rates in the two capitals (a good leading indicator for changes to the median price) are in the 50%s.

As someone that works on the ground with buyers and sellers every day, I can tell you that both states are offering good opportunity for negotiation from the buying side.

However, the other states and territories that are smaller by population (Adelaide, Hobart, Perth, etc.) are faring better for the seller — as are the bigger regional centres.

Prices in these areas look cheap to anyone living in the capitals on the east coast.

With record-low vacancy rates and rising rents, the rental crisis is leaving many investors positively geared from the get-go.

I couldn’t be more clear — we’re not on the verge of a housing crash.

The timing is not yet.

There remains a significant number of drivers against it.

Speaking of which, it takes me back to a recent interview I did with the founder of SQM Research, Louis Christopher.

Louis is a wise dude.

He’s got a better record of accurately predicting annual movements in the market than any other data provider I know.

Here are his comments to me only 4­­–5 weeks ago:

‘The RBA may well lift rates, but it may not crash the market because ofwhat’s going on with inflation.

‘That’s why I like to point out real rates.

‘What is the actual interest rate adjusted for inflation?

‘This is really important.

‘If the inflation rate is at 10% and the interest rate is at 5%, your real interest rate is actually minus 5%.

‘And when you’ve got real negative interest rates, that’s effectively like money printing. That actually still stimulates the economy.

‘A home buyer may well say, “Well, look, I can’t afford a lending rate of, say, 5%” if they’re on, say, 3% now. “I can’t afford it.”

‘Well, most likely in time, you probably will.

‘Because when you have a higher inflationary environment that’s self-sustaining. What happens is that wages go up, and other income sources go up such as rents.

‘And so, you do find, in the end, you can afford it because your own income levels are actually rising accordingly.’

The real cash rate is well below 0 — close to -4%.

We have worker shortages and low unemployment across a number of sectors.

I have mates in the construction industry that simply can’t find labourers no matter where they advertise.

It’s arguably never been easier to get a job — or for that matter, manufacture multiple streams of income via the digital landscape — than it is right now.

Speaking of the construction industry — it’s been hammered over recent years.

Rising building costs are eating into profits. We have a rental crisis, and we’re not building enough accommodation for a ‘quick fix’.

In other words — rents will continue to inflate — increasing the earnings of the land for investors. Consequently, the amount banks are willing to lend.

Add to this the ramp-up in immigration, and despite a pullback in prices in Melbourne and Sydney — and impacts from any short-term shock stemming from rising rates — the forecast for the next few years in the housing market is up, not down! (If you want to find out why I’m so confident — click here.)

However, my advice to owners that are concerned is to get their broker to review their current loan.

Lenders will be competing for the market, and there will likely be potential to save a significant amount on monthly repayments if you take the time to shop around.

Best wishes,

Catherine Cashmore,
Editor, The Daily Reckoning Australia

Dear Reader,

What ought to happen does happen…but you can go broke waiting for it.

Inflation is happening, as it should. The feds inflated the money system. And consumers are now reeling from price increases. We’re just waiting to find out what happens next. In a broad-brush way, there are really only two possibilities. Either the Fed controls inflation...or inflation controls the Fed.

Either it neuters inflation…or inflation ‘Bobbits’ the Fed.

As we’ve been describing, inflation ought to be self-correcting. Higher prices should motivate producers and discourage consumers. People should drive less. Buy less. They should stay at home and turn the lights off. Prices ought to come down.

But ‘don’t hold your breath’, was Janet Yellen’s message yesterday:

‘I do expect inflation to remain high, although I very much hope it will be coming down now.’

Ms Yellen has a remarkable ability not to notice what’s really going on. We will only know that inflation is on its way out, for sure, when she tells us it’s eternal.

Money we can trust

In the meantime, let’s try to figure out which way it will go: who will end up singing in a high-pitched, ‘castrati’ voice? The Fed? Or its inflation?

Governments use ‘printing press money’ the way a pickpocket uses his fingers. It gives them access to money that they oughtn’t have. With it, they finance programs and giveaways that neither taxpayers nor lenders would willingly pay for. Naturally, they want to keep the racket going as long as possible.

But inflation is the worst form of taxation. It strangles the goose even before it lays its golden egg. An economy needs money it can trust. High inflation rates make business, investment, and even consumer decisions much more difficult. Few people are willing to make long-term, wealth-creating investments when price increases appear ‘out of control’. Factories don’t get built. Highways aren’t repaired. Innovations and improvements don’t happen. People get poorer.

Prices in the US are rising at an official rate of more than 8%. The things people really care about — food, shelter, fuel — are going up much faster. A Fox News headline: ‘Gas prices climb 5 cents overnight; Americans are paying nearly $2 more from just one year ago’:

‘The national average gas price climbed five cents Monday night into Tuesday and 10 cents since Saturday, now hitting a record $4.92 per gallon, according to the American Automobile Association.’

Redfin says house prices were up 15%. And the FAO says food prices worldwide are up 60% over the last two years.

So, what ought to happen next? Let’s look more closely at how it works.

As bust follows boom

Some inflation is a natural by-product of the business cycle. In boom times, demand goes up…and prices with them. Then comes the bust, and prices go back down.

And sometimes prices move up simply because demand goes up or supply goes down. The approach of a hurricane, for example, has a stimulating effect on sales of generators; plywood prices rise.

Likewise, COVID lockdowns, war and sanctions, too, play a role in today’s price increases.

But there’s something else at work…something more sinister and less responsive to the natural feedback loops of an honest economy. It’s something that was underway long before the COVID Panic or the Russo-Ukrainian war. It is intentional…self-inflicted…a feature of US fiscal and monetary policy…and by extension…a mashup of the world’s monetary system.

As long as the feds keep their policies in place, we should continue to see rising prices. In fact, inflation should get worse. That’s what ought to happen too. Because natural business cycle inflation is self-correcting…wars end…and hurricanes move on. But premeditated inflation is self-intensifying.

That is, as prices rise, purchasing power goes down. Then, ‘inflation’ takes on a life of its own. People must have more money just to maintain their standards of living. Businesses, investors and the government have become accustomed to having more and more money. As prices rise, they need more money to stay in the same place. If more money is not forthcoming, sales fall…prices drop…and a recession takes hold — all the things the authorities are so eager to avoid.

That’s the ‘inflate or die’ trap we’ve been describing. Once you start inflating, you have to inflate more, or the inflation-dependent economy dies.

The strongest recovery never

What’s more, when people come to see that inflation is not going away, they get used to it. They become eager to get rid of their money as soon as possible. Instead of saving money, they spend it quickly, before it loses more of its value. This increases the ‘velocity’ of money, which in turn increases the rate of price increases.

‘Inflation expectations’ are even harder to control than inflation itself. It’s why a central bank wishing to reduce inflation must ‘get ahead of it’. It must show that it is serious by tightening up more than expected.

That is what Paul Volcker did in 1980…raising the Fed’s key lending rate to a breathtaking 20% — nearly 700 basis points ABOVE the consumer price inflation number.

For reference, the current Fed’s lending rate is about 700 basis points BELOW the CPI.

‘Nuff said’, as Howard Ruff used to put it.

Neither is the White House serious about reducing inflation. It’s the ‘strongest recovery in modern history’, say Biden et al.

‘We’re in a good position to really take on inflation’, added the White House press secretary yesterday. But the federal deficit is still on track to exceed US$1 trillion this year.

If you can’t balance the budget in the ‘strongest recovery’ ever…when can you? Never. And if you don’t get serious about tightening monetary policy when the CPI is more than 8%, when will you?

The answer is simple — when you can’t do anything else.

Stay tuned.

Regards,

Bill Bonner,
For The Daily Reckoning Australia