The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, July 22, 2010

Will house prices fall?

Next week we get the June quarter house price data from the three major index providers: RP Data-Rismark; APM; and the ABS.

With so much conjecture about house price bubbles doing the rounds, which, frankly, appears to be a universal constant in our public dialogue these days, the forthcoming release will offer a fascinating insight into what is actually happening in the market.

This topic has been made all the more interesting by questions asked by ASIC as to why investment banks have not developed products to helps mums and dads hedge house price risk (I made a similar point at some length in a 2003 report). In a speech this week, ASIC’s respected chief economist, Alex Erskine, commented:

“[L]ittle has been done to reduce information asymmetries disadvantaging buyers or to enable households to hedge their house price risks...Robert Shiller has been one of the few academics that have expounded the virtues of extending some of the innovations in finance to housing, with proposals for housing price derivatives to allow households to hedge their risks…A better housing market would involve a transparent on-exchange securities market overseen by market conduct regulators…and facilitated by risk management and hedging instruments.”

I should disclose here that RP Data, Rismark and the Australian Stock Exchange are working on a new listed market to liberate exactly the kinds of opportunities that ASIC’s chief economist outlines above. Today there are also emerging over-the-counter options to short (or hedge) Australia’s housing market. This is likely to be a very popular trade with overseas hedge funds, which tend to be bearish on Australia's housing market based on the recent US and UK episodes.**

Since October last year we have been projecting a sustained cooling in conditions back to single-digit growth rates. In the 12 months to end March 2010, Australian dwelling prices rose by a frisky one per cent per month, or 12 per cent in annualised terms. It took perhaps a little longer than we expected for the normalisation in headline mortgage rates from their low of 5.75 per cent during the GFC back to 7.4 per cent in May to bite into housing demand.

But the evidence is increasingly clear that our 'priors' were right. In RP Data-Rismark’s monthly data (APM and the ABS only report quarterly) we have witnessed the first signs of a significant deceleration in capital growth, which the RBA has also pointed to. On a seasonally-adjusted basis, RP Data-Rismark recorded dwelling price growth across Australia’s capital cities of just 0.4 per cent and 0.5 per cent in the months of April and May, respectively. That is, residential property price gains had halved from their 2009 pace.*

In the non-capital city regions, which account for about 40 per cent of all homes, dwelling price growth was never particularly strong. In 2009, RP Data-Rismark’s 'Rest of State' index registered an increase of just 7.4 per cent after falling 3.9 per cent in 2008. This year, Australia’s non-capital markets have experienced effectively no growth with cumulative capital gains of only 0.7 per cent.

The question now is what happened to house prices in the June quarter. Since we already know the results of two-thirds of the data for the second quarter (ie, April and May), which generated total growth of just one per cent, it is a fair bet that the second quarter results are going to be substantially less than the first quarter outcome of 3.4 per cent (on a seasonally-adjusted basis).

Any further softening should also be more accentuated in our monthly measures, which are not subject to the pooling biases that result in higher weights to the early months in APM and the ABS's quarterly models (ie, in the event that April and May have higher growth than June).

In thinking about current housing market dynamics, we have three leading indicators that we can reflect on: new listings; housing finance approvals; and auction clearance rates.

We know that new home loan flows have been relatively weak, and we certainly don’t have anything remotely like a credit-fuelled boom on our hands, as the RBA has argued.

The new listings story is an interesting one. Listings represent effective housing supply—that is, the stock of homes available for purchase in the market. In 2010 we’ve documented a large increase in vendors coming to market after surprisingly low levels of listings in 2009.

Last year it was almost as if vendors disregarded the underlying housing market recovery and were spooked to the sidelines by a combination of the contrails of the GFC, and perhaps the never-ending Steve Keen media tsunami.

But this year the supply-side has surged back into business, which can naturally place downward pressure on overall price growth.

The final piece of the puzzle is the well-known deterioration in auction clearance rates. In Sydney and Melbourne, which are the two major auction markets, clearance rates have declined from the circa 80 per cent levels (associated with double digit capital growth) back to more subdued 60 per cent levels, which is where they have been bobbing along for several months now.

As the chart below shows, the weaker sales market has in turn meant that relistings of unsold homes have risen in the last few months.

Our judgment is that a combination of higher interest rates, modest housing finance growth, skinnier auction clearance rates, and a surge in supply-side listings suggests that we may not see much, if any, further house price growth this year. Indeed, the second half of the year could prove to be a good time to buy.

Rismark’s analysis of the relationship between national dwelling price changes and disposable household incomes lends further weight to this possibility (see here). These two variables have displayed a clear correlation since 1993.

In the seven years following the end of Australia’s last housing market cycle, there has been no change in the national dwelling price-to-income ratio. Based on the March National Accounts data, Rismark estimates that the ratio sits at around 4.6 times, which is broadly in line with its recent average of 4.4 times.

Market economists are forecasting calendar year disposable household income growth in 2010 of around four to five per cent. Capital city dwelling values have already risen by this amount over the first five months of the year.

It will not, therefore, be surprising to see dwelling values in the capital cities track sideways for some time subject to changes in labour market conditions and the stance of monetary policy. In fact, we believe that there is a reasonable probability of some price tapering on a month-to-month basis as the market absorbs the cumulative 16.8 per cent worth of capital gains yielded since the start of 2009. This should not be shocking--the stock market suffers month-to-month price falls all the time. The national housing market's much lower volatility just means that such events are comparatively rare.

Does this have any consequences for monetary policy? In short, no. The RBA only cares about asset prices in the context of the financial system’s ‘stability’, and their nexus with the rate of change in leverage more specifically.

Equity market prices have gone nowhere for several years now (as we anticipated). Corporate lending has been commensurately anemic. Commercial property, which, in the RBA’s view, has historically been a much more worrying source of economic risk than housing markets, has similarly seen little change. And although Australia’s housing market rebounded robustly in 2010, this was not accompanied by a surge in mortgage lending.

So asset prices are off the table and, as the Governor emphasised this week, the RBA is in fully-fledged ‘inflation-targeting’ mode. Here one should not underestimate the gravity of the Governor’s task. For three-quarters of his tenure he has been unable to wrest the RBA’s two preferred measures of inflation back into the pre-agreed target range of 2 to 3 per cent (see chart below). And make no mistake. If Glenn Stevens has to risk higher unemployment and lower economic growth in order to achieve this aim, he will do so. The good news is that the two preferred benchmarks are heading in the right direction, with the futures market only pricing in one further rate hike this cycle.

Here it is important to remember that, practically speaking, the RBA no longer has a dual inflation and employment growth mandate: against Bernie Fraser’s wishes, the latter objective was explicitly subordinated to the RBA’s preferred 'price stability' (ie, inflation targeting) goal in the first “Statement” agreed between the Governor and the Treasurer in August 1996.

There are also signs that this Governor is perhaps a little uneasy about the mounting risk of the politicisation of central banking around the world as the lines between fiscal and monetary policy become blurred.

I don’t personally believe that the Governor is overly worried about the downside risks to growth. This would be a natural antidote to the capacity constraints and consequent inflationary risks associated with a new boom.

I suspect that he is spending a little more time looking over the horizon and asking himself the question, How are central banks going to maintain their independence when they inevitably have to migrate away from a 'zero interest rate policy' (ZIRP) world? That is to say, will there be political pressures placed on central banks to tolerate higher levels of inflation in lieu of low developed-world growth expectations and the adverse impact of interest rate increases on public debt servicing burdens?

*RP Data-Rismark is the only index provider to report seasonally-adjusted growth estimates.
** If you would like to find out more about these, please send a request to