Don’t bet on low rates lasting long
As we transition into another year, the main thing investors should be focused on is identifying the portents of change. It is clear folks are feeling happier. There is a pervasive sense that the world is putting the spate of 21st-century shocks behind it and getting back to business as usual.
The Australian sharemarket is up almost 11 per cent this year. Australian home values have, in the central bank’s surprisingly blunt assessment, “increased at an annualised rate of 15 per cent over the past six months”. Dwelling prices in Sydney and across the five major cities are 14 per cent and 9 per cent, respectively, dearer than they were in January 2013.
But investors in fixed-rate bonds have had a tough time, as we anticipated. Australian government bonds have delivered a total return of less than 1 per cent with the jump in long-term interest rates eroding the value of these assets. Similarly, the UBS Composite Bond Index, the benchmark used by most fixed-income funds, has returned less than cash in 2013.
Within this safer universe of assets, the standout performer has been floating-rate bonds, which generally profit in rising rate climates. A floating-rate bond is like a variable rate savings account, which moves up and down with the RBA cash rate, whereas your term deposit is analogous to a fixed-rate bond. According to UBS, Australian floating-rate bonds yielded 4.2 per cent in 2013, which is more than 50 per cent above the average cash rate.
For the time being, it seems 2014 will furnish more of the same. The RBA is a demonstrably recalcitrant rate-cutter.
Governor Glenn Stevens has clearly communicated he wants Aussie dollar depreciation to do most of the heavy lifting in his monetary policy mix. In an interview with The Australian Financial Review he argued that “to the extent that we get some more easing in financial conditions . . . it’s probably more preferable for that to be via a lower currency at the margin than lower interest rates”.
Stevens is no doubt exercised about the considerable financial stability risks if he pushed borrowing rates below their current record mark. And for the first time he acknowledged the RBA has been engaged in discussions with other regulators about how “macro-prudential” interventions could be used to throw sand in the wheels of Australia’s frothy housing market.
The extra threat of the RBA selling the exchange rate coupled with the US Federal Reserve’s (belated) commencement of “tapering” of government bond purchases has helped bring the Martin Place mandarins’ wishes to fruition.
There is every chance the Aussie dollar, currently trading at a more palatable US88¢, finds an anchor somewhere between US70¢ and US90¢ in 2014.
Notwithstanding green shoots across the economy – including recovering housing construction, record export values, reinvigorated consumer confidence and solid retail sales – economists are characteristically worried about Australia’s “sub-trend” rate of growth. Of course, nobody really knows where the true “trend” is. If, for example, annual population growth is a reasonable 1.5 per cent and productivity remains stuck around 1 per cent, then current GDP growth is actually not far from trend.
Nevertheless, while there is a dogma that governments should harness all available measures to ensure we stay at or near the theoretical trend rate of growth, there is a small chance local rates could yet fall further.
My best guess, however, is that as the impact of the four easings we’ve had in the last year continues to work its way through the system, asset pricing will shift to recognising the likelihood that rates will have to be normalised. And contrary to some hype, current credit costs are not remotely near this new normal.
Stevens’s recent remarks on the possibility of applying macro-prudential tools to hedge against brewing bubbles were revealing in this context. While conceding they could be “a useful adjunct to other policy tools to help manage tensions”, Stevens chose to highlight that one cannot use these regulatory interventions “over a prolonged period to try to make up for the fact that the price of credit is not in the right place”.
This brings us back to the $4 trillion housing market, which is the cornerstone of consumer wealth and all bank balance sheets. One fascinating feature of its dynamics in December is that we have not observed the sharp seasonal slowdown one would ordinarily expect.
In the final month of the year, prices often slump and growth is typically one percentage point lower than trend. Yet auction clearance rates have held up unusually well and properties have continued to grind out capital gains.
Combined with a tsunami of speculative investment activity, and the untapped leveraged demand in the $500 billion self-managed super sector, this suggests that the current boom could have some way to run. It is easy to conceive of a situation where national house prices, which are already at all-time highs, climb 10 per cent over 2014 if the cost of borrowing stays at its current level. That would make Australian housing more expensive than it has ever been by June next year.
If the unemployment rate begins to stabilise, which it should do, the RBA may be quick off the mark with its first brace of hikes. By this crucial juncture, multi-asset class investors should be prepared for some serious changes.
In particular, they should be able to punch out positive total net returns while absorbing losses across their equities, property and fixed-rate bonds exposures.
The author is a director of YBR Funds Management.
Posted by Christopher Joye - Australian Financial Review on 20th December, 2013 | Comments | Trackbacks
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