This is beginning to be one of those years where at the start you try to imagine all the things that might go wrong - and then watch as, one by one, all those things duly DO go so very wrong.
Less than two months ago I opined as a kind of scene-setter for the year. And in that piece I raised the prospect of either a 'hot' or 'cold' war involving Russia. I talked about rising inflation. And I mentioned Omicron.
Perhaps one thing I didn't do strongly enough is link the way those things could all act together to form an almighty inflation cocktail.
So, okay. Omicron. I guess the question was always going to be what the approach would be to it in China. Well, turns out the approach is the same as it's been with any old Covid - lock up your citizens and snuff it out. But Omicron? We didn't even try that here. And we were pretty keen on the 'snuff it out' approach.
I will stick my neck out right now and say that this time this is not going to work for China - and that's bad news for all of us. You can't just shut huge (26 million population) cities like Shanghai without having a massive impact on the global economy.
Now, yes, China did of course close down ports and factories etc in the original 2020 outbreak. But remember, the rest of us were all in the same boat. Closed for business. So, Chinese factories and ports were not operating at a time when there was little demand pressure from the global markets.
Not now though. There's plenty of demand. Too much. Which is still struggling to be satisfied by groaning supply chains.
And now we have parts of China shutting down again?
And what is the endgame for China? Do they think they can hold Covid back in perpetuity?
For me these latest moves suggest an underpinning anxiety/realisation within China that the Chinese population is not properly covered against the worst of Covid. Simply put, their vaccine was not good enough, so, they keep having to wrap their people in cotton wool, maybe while they develop a better vaccine.
Look, I hope I'm wrong about that. But it seems to me there's no future in forever having to lock down in an attempt to keep holding back the virus.
But this is not just China's problem. It is our problem.
All this can lead to is more and more disruptions to supply chains - at a time when, let's face it, things are stressed enough. A free run for Mr Inflation.
Given these developments in China, I really do not think things are looking too flash for the rest of the year. And let's face it, they weren't looking great before.
Remember, this is coming on top of the huge disruptions from Putin's War.
I was concerned earlier this year whether we might get a 'hot' or 'cold' war. Well, turns out we've now actually got BOTH running in tandem, with no clear sign of when, or if, either will end.
So, while economists might still be hopefully suggesting that global inflationary pressures are about to peak, I'm really not so sure.
But anyway, that's how the world is. What about our little part of it down here in the Pacific?
Well, not great either really.
Inflation's up. Wage claims are up. Omicron is having a severe dampener on activity levels and confidence. The housing market has lost its mojo.
On inflation, I would not now be surprised to see it hit double digits by the end of this year, particularly if disruptions in China go on - as I fear they will.
The Reserve Bank is set to hike interest rates again next week (April 13) as it tries to get itself a little less behind the inflation eight-ball.
The only question for the central bank next week is whether it raises the Official Cash Rate just to 1.25% (from 1.0% currently), or whether it has a double-dip and hikes it to 1.50%. My money is on the latter, because I think the 'market' has been well-enough conditioned to expect that. And the RBNZ does have to send a signal that it is on the case and acting with urgency.
That brings us inevitably on to mortgage rates. These worry me.
The rates have already moved up a long way - and yet the RBNZ has barely got started yet with OCR hikes.
What about interest mortgage debt servicing costs? RBNZ averages for a year ago - the month of April 2021 - suggest one could have secured a one-year fixed 'special' mortgage rate of 2.3%.
As of this month (April 2022) we're now looking at 4% to 4.2% for a 'special' for the same term.
The significance of that of course is that someone who got a mortgage at 2.3% a year ago might now be looking to re-fix at, say 4% (if they are quick!)
The average-sized mortgage taken out in April 2021, according to RBNZ figures, was about $335,000.
So, the interest.co.nz calculator tells us that over a 30-year term, someone with a $335,000 mortgage at 2.3% would currently be paying $1289 a month.
If we switch to paying 4%, then the payments go up to $1599 a month - so an extra $310 a month.
Now, people should be able to find that, given that the payments weren't huge in the first place. But, my goodness, they will notice it. Particularly with the general cost of living shooting up, with inflation likely to rise above 7% very soon.
On affordability and serviceability, the last time I looked (some time ago when interest rates were very low indeed) banks were testing mortgage applicants for serviceability at about 6% to 7%. Supposing that everybody has been giving correct information to their banks therefore (hmmm), current mortgage levels should be okay for people.
But I would be concerned if we saw average mortgage rates starting to get above 6% - and we are not too far away from such a situation now.
All of which brings us back to the likelihood of reduced spending and what that might do.
The big silver lining in New Zealand is the extremely low unemployment rate (3.2% as of the December 2021 quarter). Clearly, as long as people still have regular money coming in they can meet the mortgage payments and buy food.
For me, the biggest thing to watch in this country during the rest of 2022 is what happens to that unemployment rate.
The labour market is still incredibly hot at the moment. But, with winter coming on, Omicron very much around, supply chain problems ongoing, oil prices likely to stay up, mortgage rates likely to keep going up - it seems inevitable spending will reduce further. And that could tip over some businesses.
It would be very surprising to me if we can maintain such a buoyant labour market for the rest of 2022. But we will have to wait and see.
If significant numbers of people were to start losing jobs that would be when the trouble really starts. Because then we could see forced house sales and the like.
So, here's hoping we do all keep our jobs, because that's our best bet of coming through such a difficult time in reasonable shape. Oh, and hope like hell this crazy world doesn't throw yet another curve ball. Enough already.
86 Comments
Yes , that too. We can learn from repetition, right ? I Can Show The Number 7 In Many Ways.
But tonight my friends TTP will do this (again) for me.
Take it away TTP.
Seven is considered to be the luckiest lucky number. Stirling Moss always raced under number seven if he could. He was sufficiently talented to become one of the greatest ever racing drivers ,extremely fast, won many many races, grand prix and sports car events, and was unlucky not to win the Formula One Championship. You could probably call that a draw then for number seven.
Good thoughts P8 - here's the chart of the US 30 year fixed mortgage rate vs CPI. Note the quite significant anomaly that is currently playing out with inflation rising much faster and steeper above the mortgage rate. There's been noting like in in the last 50 years. CPI has more or less always been below the mortgage rate. Strange times we live in.
1970's is perhaps the closest and those conditions resulted in recession and negative real returns for house prices.
Also note that during the GFC, CPI got close to the 30 year mortgage rate....this time its blown right through it. What does this mean? I guess time will tell.
Question is, how aggressively will the Fed raise the funds rate to try and control that inflation and what will be the consequences of that?
On that topic.....here's an article from the WSJ....apparently Powell is a Paul Volcker fan...so he may do what is required from a Fed funds rate perspective to reign in inflation...but that could be very bad for asset prices (nominal or real).
1-2 year rates will be around 7% at some stage, 4 and 5 year rates are going to the 8-10% range.
Banks will then start to push up the 1-2 and floating rates so people dive into the 5 year rate in panic before rates start to go into a down cycle again 1-2 years away. This is what always seems to happen.
If I was being selfish, as a non home owner, forced property sales wouldn't be a bad news story. Even if I was forced to be unemployed for a year, the fall in house prices would more than compensate. A crazy situation that I'm sure applies to most of the workforce under 30.
Absolutely....a year of unemployment, if it means house prices fall 40-50%...for the FHB would mean a mortgage that is hundreds of thousands of dollars less over the next 30 years.
So by being unemployed, they are actually becoming financially better off in the long run...sounds bizarre but it would be far better than the status quo of having to take out a $500,000+ mortgage just to buy a starter home.
Oddly, you view this over a 30 year period, the year of unemployment when you consider the total principal and interest repayments that would be saved if the new mortgage was $250,000 less (or more).....would mean that the FHB who was unemployed for the year, would effectively be making hundreds of thousands of dollars a year by sitting there doing nothing watching house prices fall, and limiting the extent of their debt slavery over the next 30 years.
If we switch to paying 4%, then the payments go up to $1599 a month - so an extra $310 a month.
That's $310 lost to consumption and the spending desperately needed in the consumer sectors of the economy. That negatively impacts revenues, profits, and incomes. That's not good for the property bubble as people's attitudes and behaviors change.
It's all interconnected. Robbo and the new brass at the RBNZ should not be sleeping well at the moment.
The Roy Morgan Consumer Confidence Index fell to its lowest level ever in March. Index has been running since 2004.
https://www.roymorgan.com/findings/8938-anz-roy-morgan-nz-consumer-conf…
Unfortunately yes, that's how you deal with an overheated economy first, by reducing spending. After 40% housing price increase after pandemic and being able to access cheap loans, people have been encouraged to go out there spend, and even spend the money they haven't earned. It clearly shows now the supply can not catchup with such demand. So the demand will have to come down first.
That's an impressive chart eh JC......but really who needs consumer confidence in a period of rising inflation, when the average kiwi home is a million dollars!
Apparently, according some property lovers, everyone just buckles down and pays their mortgages in times of trouble, but with little consideration to the impact that this has on the wider economy (via reduced spending/consumption). House prices can keep rising, even when the economy is terrible. But then actually a bad economy is a great outcome because it means the RBNZ will drop interest rates again and house prices can go up even further!
You can never lose via debt speculation...
We will certainly suffer from increasing interest rates and a contracting economy at the same time in this cycle. Just because an economy suffers doesn’t mean interest rates go down.
And China’s problems are four-fold. Covid plus massive private debt and personal wealth contracting from investing in property, plus food shortages which were already on the cards before the war. They were expecting preferential cheap supply of wheat, coal, and oil out of Ukraine and Russia which hasn’t eventuated (yet). They may yet suffer sanctions from supporting Russia too. This toxic melting pot may just be enough to start a war… the communists get social instability under control by drumming up nationalism. Best way to do that is a good war!
Labour can/is chucking more money at poor people, thus allowing investors to service their mortgages through increased rents.
When immigration ramps back up investors will be able sustain rents [mortgage repayments] through continued overcrowding.
Investors have underutilized the huge pool of wannabe renters living in government funded motels and on the government's housing waiting list. These people are usually milked by the social services industry - time for investors to have their go on the teat.
Inflation is ridiculously high and the OCR is only 1%. The average Auckland house price could easily top 2 million by this time next year.
Some stretched FHBs might have to sell, but plenty of investors have on-demand access to the credit tap and can step up to keep prices high.
Housing is really a political choice. More 'money printing' will occur and prices will go up, even if it means debasing the NZD. "The spice must flow" as it were.
Eventually there will be a crash, but who can say when that will be.
It's a narrative that could very well be. Unfortunately, I think there's too much Never-never Land thinking among the govt and the RBNZ. I think this playbook has its weaknesses and don't be surprised if it all comes down in a screaming heap. That's not DGM thinking. It's simple scenario mapping for risk management.
J.C. I tend to agree with you.
Often before a property cash there is a 'blow off top', this may or may not have already happened. Hindsight is 20/20 of course.
I rent so a property cash could be advantageous for me. There are always winners and losers in a market.
Or, you know, just the US model where the wealthy exploit the poor and that's about it.
Over half NZ's welfare goes to the universal benefit for oldies, and plenty to landlord and business subsidies. While more people are falling out the bottom into homelessness.
But maybe we do have a dependency problem among property speculators.
According to MSD in 2017/2018:
$25.09 billion
- Departmental operating costs: $1.03bn
- Student support: 1.95bn
- Housing assistance and rent payments: $2.26bn
- Benefits and assistance: $5.91bn
- Contracted services: $0.17bn
- Debt write-off: $0.07bn
- NZ Superannuation: $13.7bn
https://www.msd.govt.nz/about-msd-and-our-work/publications-resources/c…
Couple of points worth making here
1) As you say, mortgage rates have risen much more quickly than OCR increases - the expectation of continued OCR increases is priced in. I wouldn't be surprised if a 25 basis point rise at the next meeting led to mortgage rates decreasing or the rate of increases slowing.
2) Seven! Is the number of beers I hope to have tonight. Doing my best to support the hospitality industry in this tough time.
3) Inflation caused by war is very typically 'looked through'.
4) Seven! Is the number of maidens I will bed by the end of the year. Probably not, but if I say it often enough it'll happen right?
5) Monetary policy is typically impotent in the face of stagflation. The response has to be fiscal faced with high inflation and deteriorating economic conditions. Anything who thinks that RBNZ if presented with : 10% inflation, -5% econ growth, increasing unemployment would raise rates - doesn't understand monetary policy. They won't blindly crash the economy to control inflation.
6) Seven! Is the % gross yield I achieved on a property sale last year in a high capital gains area. I wouldn't expect prices to fall by the insane amounts some commenters here believe they will.
Regarding point 5, economic growth, to that you appear you know the way better than the guy driving the bus:
Mr. Powell was asked this month if the Fed was prepared to do whatever it took to control inflation — even if it meant harming growth, as Mr. Volcker did.
“I hope that history will record that the answer to your question is yes,” the Fed chair replied.
https://www.nytimes.com/2022/03/14/business/economy/powell-fed-inflatio…
Also if Omicron is causing deaths and hospital overload on a highly vaccinated population, imagine what delta would have done on an unvaccinated one. Even if you forget the deaths, the economic consequences would be massive as people stayed home in fear. Much worse than partially locking down 1/3 of NZ.
"Clearly, as long as people still have regular money coming in they can meet the mortgage payments and buy food."
Not clearly at all....when outgoings exceed incomings employment status is of no import.
Not only are mortgage rates increasing but you can add food, insurance , rates, energy....virtually everything, but wages?....not so much for most.
And 2.3% to 4% is generous......try 1.99% to approaching 5%, with worse to come.
No matter whether you think inflation is caused mostly by logistical problems (which I don't) or by structural economic problems (which I do), none of the factors causing it have gone away. We have nothing but wishful thinking.
NZ economy is going to tank harder than anything we've seen since the '30s over the next 2/3 years. I guess you could call me a DGM, lol.
I wasn’t around in the thirties, but not far away. Parents & grandparents never ever lost an opportunity to recount the dire circumstances, a black cloud seemed to always be on the horizon. Around the world nations eventually clawed themselves upright again. Working for the state, public works programs, put food on the table so to speak. Big difference now though, none of those workers then as such, had maxed out credit cards and other similar liabilities yoked to their necks. It’s a bit like being in a mountain range where any little slip can instantaneously be an avalanche and there are huge black clouds towering overhead.
Yes the depression and war/s definitely shaped those generations differently. The greatest generation knew how bad things can/could get and appeared to show far more humility and cautious approach. I find boomers on the other hand generally view everything with a sense of invincibility because its been relatively calm sailing for their entire lives and as such assume that this is normal and that therefore bad times never will exist in the future.
Suggest they might and its a conversation they generally have no interest in, or either that its important to dismiss the view as somebody being a doom, gloom merchant! (so an element of denial that bad things could ever happen).
(this is reflective of the generations as a group in my experience, and not of some individuals within those groups....but the greatest generation certainly have/had different values/behaviours to their boomer children).
Interesting thoughts.
China has a company with a license to produce the Pfizer vaccine but unfortunately authorities won't approve it. Play stupid games, win stupid prizes.
The inflation question is really two pronged, yes supply chains etc. have been part of it but the really slow response of Reserve Banks to removing stimulus measures has been the other half.
Mortgages shouldn't be an issue until rates get to whatever the test rate was over the last few years (circa 7 or 8%?) When they do though people will start to have to make some very difficult decions like "Can I actually afford a house?" or "Can the bank renegotiate the terms of the loan?"
The test rate is a misnomer though, it's really only valid for that koment. How far can you really carry it into the future, you can very easily spend out your buffer on extras and live more lavishly up to the point you're only just making mortgage payments.
I suppose some of these things you can just stop, but the two new kids since buying the home two years ago will certainly be hard to cut costs on.
It's based on the idea that people would cut discretionary spending to pay the mortgage. The issue I see is that if inflation is allowed to run above wage growth for consecutive quarters (or years even!) it'll erode the ability of those liable for payment to meet their obligations.
Rates rise as well as fall, it's part of the normal economic cycle and should be "business as usual" for commercial banks to manage with their clients.
According to RBNZ the weighted average test rate is just over 6%.
It is a lot lower than most people think, and a lot lower than most newspaper reports would have us believe.
Plenty of mainstream "expert" commentary still bandies around the old myth of 6-7% test rates. The reality is that the AVERAGE test rate is around 6%, meaning that many mortgages have been tested under 6%.
It was briefly 5.8% last year according to this website. Either way the affordability of loan repayments is a matter for banks and their clients, RBNZ can't save commercial banks from arrears and defaults due to their own policy mistakes. The level of profitability is sufficient to absorb losses and move onwards far wiser.
The loss of interest tax deductibility on rentals is a generational change if it becomes embedded. While people hold their properties they will really slow down spending, and should they sell the tenants won't be able to get another rental because investors have stopped buying. Maybe the government will give them a loan to buy a home?
The winner is big government-sponsored social housing providers. Follow the money and ideology.
Always interesting and usually informative reading both the articles and comments
Appears lots dont understand boomers -or under estimate us. I know generalisations but lots of us appreciate that we had it good and often understand that its payback time - I believe we have a new children's hospital in Wellington due to this attitude. We do know that our grandparents and often parents had it tough - many were kids in the depression - so they taught us to how to cook, repair our clothes and belongings etc - and we do know what 1987 economics looks like and the issues caused - and dont all see the current house market as a win -so my advice is dont under estimate boomers ability to lead and to solve problems - we have lots of experience
We also like facts to run the show not emotive spin
As for inflation - after 25 plus years in business in NZ the biggest cost increase driver is the NZ Govt - and we are in the middle of the food chain so it will definitely flow through. Energy + 40% - power companies majority owned by the state, insurance - including govt levies, rates -above inflation for 10 years, govt charges maf mbie etc - and payroll costs where trainee labour is now priced out of the market and other govt charges eg ACC also up ( other wage increases are my choice as I do understand how tough it is for them)
so its becoming baked in - Robertson assisting driving inflation up while Orr looks to drive it down - a complete cluster led by incompetence and spin
Buckle in for a wild ride
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