Is the Economy’s Recession-less Run Ending?

If it was one media outlet, we’d dismiss it. Besides, journalists report the news, not make it. But this is just bizarre. While the Aussie stock market hits new post-GFC highs, everyone is miserable.

The Australian Financial Review reports that ‘Household debt “getting close to limit”. Limit? There’s a limit?

Nomura analyst Victor German pointed out we’re closing in on the financial crisis high of 150% debt to disposable income. Despite the low interest rates, the interest to income ratio is ‘remarkably high’ too, according to Commonwealth Bank head of fixed income research, Adam Donaldson.

The real worry is that it’s very difficult for households to borrow even more. And without more borrowings, who will buy houses?

Then there’s the potential for interest rates to rise. The Reserve Bank of New Zealand just raised theirs again. Luckily for Australian home owners, the inflation data here came in just below the 2–3% target, so rate rises aren’t in the cards anytime soon.

Cue bizarrely pessimistic headline number two from ‘Australian Property Prices Ready to Pop. Remember when ‘pop’ meant increase? Well these days it apparently refers to the housing bubble popping.

Australian Property Monitors published a report that house prices are rising at their slowest rate in a year. That doesn’t sound so bad right? Well the twist is that they’re bifurcating. While Perth, Brisbane, Darwin, Canberra, Adelaide and Hobart all posted flat or falling house prices during the March quarter, Melbourne and Sydney continued to surge. Hobart units fell 8.4% over the last year while Melbourne just reached a record median home price of $604,110.

In the US, property prices fell in fringe cities before infecting the major ones. As we often mention, property prices are all about momentum. While they go up, problems can’t emerge because people can simply sell out for a profit. But as soon as enough overleveraged sellers see prices fall and panic, they’ll infect the rest of the market. The point at which more money can’t be borrowed usually signals this moment.

We’d like to borrow a real estate term to describe what’s happening. This is a ‘twilight auction’. Property appears nicest just before a long cold night.

That’s far from saying prices can’t go up. Momentum is still momentum in Sydney and Melbourne. Who knows how much debt Aussies are willing to go into?

David Einhorn, a legendary hedge fund manager and poker player, joined the media’s pessimism by announcing that technology shares in the US were in another bubble. There simply aren’t the earnings to back up ridiculous stock prices in tech companies.

Cue earnings announcements for Facebook and Apple. Facebook’s net income tripled and trounced analysts’ expectations. Apple followed on with far better than expected results thanks to iPhone sales in China. It even upped share buy-backs.


Einhorn will be far from fazed. But it does make for amusing reading.

It seems unlikely that the media would manage to announce the end of a debt boom, property bubble and tech bubble on time. What the coverage does show is the reasons and logic for rough times aren’t completely absent from journalists’ and the public’s mind. They won’t even be able to write ‘nobody saw this coming’ if it happens and they write about it.

What this means for you is that the end of Australia’s recession-less run is waiting somewhere. Even the US is due for another recession — they happen periodically over there. But when will the economy turn down once more?

One of the best indicators is usually the bond market. The problems is, it’s being manipulated and seems thoroughly confused.

Consider this chart. It shows where the market expected interest rates in the US to be over time. So in 2010, traders expected rates to steadily increase and rise above 2% by mid-2011. In 2011, they expected them to stay low till 2012 and then rise to above 1%.

click to enlarge

Years later, the rate is still effectively at 0%. But the forecasts still predict increases.

What’s interesting here is that the market has been pricing in a genuine recovery, which comes with interest rate hikes, for a very long time now. The expected fed funds rate has a big impact on the rest of the economy. With reality consistently falling short of expectations, distortions must be building up.

If you expected interest rates in Australia to rise 2% over the next year, it would change your behaviour. You might avoid going into debt or buying a house.

The Federal Reserves response has been to promise low rates further and further into the future with ‘guidance’ and ‘thresholds’. But it’s not working. The market still predicts increases.

In other words, the Fed Funds Futures market, where prices reflect expectations on interest rates, has now been crying wolf on higher rates for years. And still the rates are low.

What if we simply live in a 0% world now? And quantitative easing is the new interest rate which central banks use to keep the economy chugging along? Or what if the market eventually grasps that rates are nowhere near going up and you really can borrow vast sums of money ridiculously cheaply?

One thing’s for sure. The markets are still pricing in the old normal. Or at least a return to the old normal. But we don’t think that’s going to happen, as we’ll discuss next week.


Nick Hubble+
for The Markets and Money Australia

Join Markets and Money on Google+

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money