Saturday, 26 December 2015

Australia needs more cash!

Blog Post 11| 28th October 2015

Australia needs more cash!

One of the major changes that has occurred over the past 20 to 30 years, since the days of financial deregulation, is the decline in the percentage of cash (liquid of currency) to bank assets (private debt). See graph 11.1 below:

Graph 11.1

This is significant because a ratio of this nature represents our nations ultimate ability to pay off the e debt. In other words, the private sector using a bigger credit card to finance the existing credit card debt. The credit card being an analogy as most of this debt is these actual loans that are collateralise with assets. Albeit, there is an argument for these loans being undercollateralised on the back of overvalued asset prices, but lets not go there for now.

Over time the common trend is that when interest rates are decreased (through the cash rate)currency volumes need to increase to reduce the value of money into the future. Similarly, when interest rates are increased, currency volumes need to decrease to increase the value of money into the future. In order to balance the ratio of cash to private debt, interest rates will need to come down further, in conjunction with some form of quantitative easing (increasing the currency supply and circulating this currency through buying government bonds from the banks). 

An argument for a sustainable rise to the cash rate in the near future has little merit given this long term trend.

Tuesday, 27 October 2015

Interest only mortgage loans under scrutiny by ASIC

 Blog Post 10| 27th August 2015

Interest only mortgage loans under scrutiny by ASIC

The Australian Securities and Investment Commission (ASIC) are cracking down on interest only loans in the mortgage market suggesting a portion are at risk of default. This is an important initiative on the behalf of the regulator watchdog as in the mortgage market owner-occupiers mortgages interest only repayments equates to over 25% of the market and in the investor mortgage market this statistic is up around 60%. See chart 10.1 below from the March 2015 RBA Financial Stability Review:

Chart 10.1

The ABC News quoted ASIC last week saying:

'Interest-only loans offer a period, typically up to five years, where the borrower only has to pay the interest on the loan, rather than also paying down the principal.

This makes repayments lower in the short-term, but higher over the life of the loan.

'The ASIC review of 140 individual loans found that in more than 30 per cent of cases there was no evidence the lender had considered whether the applicant could afford their repayments over the long term.

ASIC said in 20 per cent of cases the lenders had not considered the actual living expenses of applicants and in 40 per cent of files they had incorrectly calculated the affordability of the loan.' Click here to reference the article.

However, as mentioned in an article from Banking Day yesterday - ASIC's call for better responsible lending compliance easier said than done. ASIC is questioning a large percentage of these loans they have reviewed to date suggesting lending practice regulation were not met. Gadens Lawyers said;

'"ASIC found that most lenders did not appear to be making sufficient inquiries in relation to requirements and objectives or, if they were, lenders were not recording their findings."'

King & Wood Mallesons law firm said;

'"ASIC comments that in the context of an interest-only loan recording the objective or requirement of a borrower is ‘to purchase property’ is insufficient because it does not address why an interest-only loan as opposed to a principal and interest loan would better meet the borrower's objectives... Without ASIC providing guidance on what is appropriate for each type of credit product it is hard to know what will satisfy the obligation."'

Wednesday, 26 August 2015

Just in time delivery

Blog Post 9 | 5th May 2015

Just in time delivery

The decision by the RBA to cut the cash rate by 25 basis points in May has proven quiet effective in stabilising money markets since early May. 3 year CGS yields have normalised to above 2 year CGS yields, though this spread is again narrowing. 

Meanwhile the RBA is in between a rock and a hard place; a tiring economy that yearns for liquidity to improve the balance sheets of banks facilitating improvements to borrowing throughout the economy (enabled via reducing the Cash Rate) and a hungry housing market that is gobbling up cheap money, making housing less affordable and generating a potential asset bubble. 

For now, the stabilisation of money markets suggests that May rate cut decision was timely. The economic picture could have been quiet different now and into the future had they continued to hold off on cutting the cash rate.

Friday, 19 June 2015

Will they cut in May?

Blog Post 8 | 5th May 2015

Will they cut in May?

The 30, 90 and 180 Bank Accepted Bills (BABs) rates dropped to 2.15, 2.17 and 2.25 per cent respectively yesterday (04/05/2015). An increasing amount of economists are siding with the argument for a rate cut. Will the RBA pull the trigger at 2.30pm today? Or, will they play devil advocate?

Monday, 4 May 2015

Even more signals for lower interest rates

Blog Post 7 | 21st April 2015

Even more signals for lower interest rates

The spread on 3 year Commonwealth Government Securities (CGS) and 2 year CGS has widened to 5 basis points; 1.82 per cent and 1.87 percent respectively as at 20th April 2015. This indicates that fund managers prefer 3 year bonds to 2 year bonds as they foresee the cash rate being lower for longer on the back of Australian economic conditions continuing to deteriorate.  

Monday, 20 April 2015

Should the cash rate have been cut on Tuesday?

Blog Post 6 | 9th April 2015

Should the cash rate have been cut on Tuesday?

Callam Pickering from Business Spectator wrote a great follow up piece to the absence of a cash rate cut on Tuesday entitled Has monetary policy failed Australia’s economy? The article raised the question ‘What’s the counterfactual?’ … i.e. ‘Based on the historical relationship between interest rates and growth, there is a non-trivial possibility that if the cash rate was at, say, 3.5 or 4 per cent, then the Australian economy would either be in a recession or well on its way to one.’ Callam raises a very interesting point of the consequences of not cutting the cash rate in time before it causes adversity to economic growth and conditions, and having formerly worked for the Reserve Bank of Australia his opinion is one of validity. 

Wednesday, 8 April 2015

An April Cash rate cut is looking more likely

Blog Post 5 | 3rd April 2015

An April Cash rate cut is looking more likely

The 30, 90 and 180 Bank Accepted Bills (BABs) have all dipped below the Cash rate in recent days. This will put pressure on the RBA to reduce the Cash rate this coming Tuesday when it goes to board for this month. Chart 5.1 shows the BABs rates against the Cash rate for 2015:

Chart 5.1 
Preliminary research indicates the annual inflation rate rose to 1.5 per cent last month, which is still below the RBAs 2 to 3 per cent target range. This also supports the case for a lower cash rate this month.

Monday, 6 April 2015

More signals for lower interest rates

Blog Post 4 | 23rd March 2015

More signals for lower interest rates

The market for 3 year CGS did stabilise in mid-February to mid-March, with yields rising back to a normal level above 2 year CGS yields. However, this was short lived as demand for 3 year CGS has driven the yield again below 2 year CGS yields in recent days. See table 4.1 below:

Table 4.1

Who is paying the additional interest on the debt?

Blog 3 | 24th February 2015

Who is paying the additional interest on the debt?

Much has changed in the world since the Financial Crisis of September 2008. Structural changes to financial markets have been a necessary evolution from this broadly unforeseen event. One of the major structural changes here in Australia has been the issuance of Commonwealth Government Securities (CGS) that has grown over 6 fold since September 2008; Australian Financial Intermediaries(AFIs) being are the largest domestic buyers of these instruments. The main reason for this is to ensure that in the event of a future financial crisis here in Australia the RBA would be able to inject liquidity into to AFIs quickly by printing currency and buying these holdings of bonds from the AFIs in a process known as Quantitative Easing (QE). This precautionary measure places the Australian banking system in much better position to weather a financial storm, but does come at a price. Chart 3.1 shows the change in the holdings of CGS and local and semi-government and other public authority securities by AFIs since January 2000.

Chart 3.1

The Australian Office of Financial Management (AOFM) is the body responsible for managing the market for issuing CGS. They regularly update the value of CGS on issue on their website Graph 3.2 shows the growth in CGS on issue since January 2000.

Chart 3.2

As at January 2000 when the Cash Rate was 5% interest on CGS was an average of 6.88% pa (across the 2yr, 3yr, 5yr and 10yr terms), which on an account of AU$79.78 billion was AU$5.49 billion pa. As at September when the Cash Rate was 2.5% interest on CGS was an average of 3.01% pa (across the 2yr, 3yr, 5yr and 10yr terms), which on an account of AU$368.47 billion was AU$11.10 billion. Chart 3.3 shows the quarterly change in annual interest on CGS since March 2000.

Chart 3.3

The question is - who is paying the additional interest on the debt? And, who should be responsible to pay it?

Cut or Not To Cut…

Blog post 2 | 3rd February 2015

Cut or Not To Cut…

As we get closer to the release of the RBA’s interest rate decision release today at 2.30pm AEDT, one of the key factors they will need to take into account is the Bank Accepted Bills (BAB) data which estimates end of day bank bill rates. See Chart 2.1 below:

Chart 2.1

Without an interest rate cut and an increase in the supply of liquidity, the cost of funding between the banks in the short-term will undoubtedly rise.  

Interest Rates in 2015

Blog post 1 | 6th January 2015

Interest Rates in 2015

Happy New Year everyone!

We thought it would be a great idea to kick off 2015 with a blog to help provide more information around what is happening in the Australian economy. 2014 was an economically challenging year on many fronts; the Federal Government’s efforts to balance the budget have put negative pressure on national spending, the consistent downward trend of commodity prices since February-March 2014 has downsized the flow of funds from the mining boom, unemployment has steadily crept up to 6.3%, and business and consumer confidence are both declined to lows in the final reports of the year.

It is for this reason that many senior banking economists have revised their outlook for future changes to Cash Rate by Reserve Bank of Australia (RBA). NABWestpac and Deutsche Bank all foresee a 0.5 percentage point cut for 2015, with a 0.25 percentage point cut in first few months of the year. This prediction is in line with the trending market yields on Commonwealth Government Securities (CGS), which are bonds issued by the Federal Government. Chart 1.1 shows this relationship in a graph.

Chart 1.1

The market for CGS is seen to historically lead the Cash Rate, as these yields are a reflection of the market price for the future value of money. The Cash Rate is the interest rate that the RBA sets in the market for overnight funds between the banks. When the RBA reduces the Cash Rate they increase the supply of cash (currency), which in turn dilute the value of money into the future.

Chart 1.2 shows a close up of the resent downward trend of CGS.

Chart 1.2

CGS to Cash Rate

Note the trend of 2 year and 3 year CGS circled in red; 3 year CGS have in recent weeks trended lower than 2 year CGS. What this indicates is that investors (albeit fund managers who represent their investors) expect interest rates to be lower for longer so they see more value in holding 3 year bonds over 2 year bonds. In other words, investors are not confident that the Australian economy will improve enough to warrant the RBA to raise the Cash Rate any time soon.

Ultimately, if the market for CGS continues to decline it is likely that we will see interest rate cuts into 2015.