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Monday, 27 November 2017

At any rate...

At any rate...

Trying to second-guess where interest rates are heading has almost become a national sport in Australia, so I've been trying instead to write about a range of other topics lately. 

Nevertheless, an interesting titbit from Bill Evans of Westpac this week is worth looking at.

Later this week the Reserve Bank of Australia (RBA) will report its household credit growth numbers, with annual growth to households seeming likely to slow over the months ahead, partly due to tighter lending criteria. 

Evans was able to ask the RBA Governor during a post-speech Q&A session how he'd view the prevailing levels of credit growth of around 6 per cent, if income growth was to return to 3 to 4 per cent by 2018. 

"His response was clear. He accepted that household credit growth at around 6% (not even meeting the slowdown which I expect) was quite okay, implying that even if leverage was rising due to tepid income growth, financial stability was not being threatened."

The full note from Evans is well worth a read. 

It's significant, because it appears to all but rule out interest rate hikes in the event of moderating credit growth, even if household leverage rises a bit further. 

Given the low inflation environment and the Governor's reluctance to cut rates further, the only reasonable conclusion seems to be to expect interest rates to be on hold next year, and quite possibly for the next two years (cash rate futures are pointing to a possible hike around the middle of 2019). 

Bonds price lowflation

There's been quite a bit of discussion of bond yields over the past week or so.

Although lower than in the past, in recent times Australia's government bond yields have been higher than elsewhere in the developed world (US, Japan, Germany, UK), as global rates have plummeted, even turning negative in some countries.

Australia has a 2 to 3 per cent inflation target, which is higher than many other countries, but our inflation target has been consistently missed on the downside in recent quarters.

Aussie bond yields have consequently been on the slide again since the September quarter as markets adjust to the low inflation environment and outlook. 

Bond yields, particularly 10 year/2 year spreads, are said to be a reliable indicator of recessions - or market's expectation of a coming recession - if they turn negative. 

Normally investors are expecting lower returns when their capital is tied up for a shorter period, logically demanding a higher yield on longer term investments. 

But the yield curve can become inverted when the market has sagging confidence in the near-term economy (and consequently yields, as bonds are rolled over), and in these circumstances investors may accept lower returns for tying up their capital for a decade. 

Australia last saw this indicator flashing between June 2006 and July 2008 as the financial crisis unfolded.

The yield curve doesn't seem especially troubled now, despite a bond rally since the beginning of the year, implying a low risk of recession.

Westpac expects to see the economy having grown by about 0.9 per cent in the third quarter (the official estimates aren't reported until next week), with growth of about 3 per cent in calendar year 2018.

However, persistently weak inflation figures do suggest that interest rates will be lower for longer, even if the next move does prove to be up.

Westpac is now offering via mortgage brokers 3-year interest-only fixed rates for investors from 4.29 per cent (a discount of 0.50 per cent), with lower rates available on a 2-year fix, perhaps a signal that interest-only lending will resurface in 2018.