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Having returned from a months holiday abroad, I’ve had plenty of time to read the wider world news and reflect on what will drive the Australian economy in the next few years. It is always interesting to look at the Asian view of Australia. In the past month, all that made the news was the boat people scheme for PNG.
“Which led me to think, what matters?
With the huge diet of news that we read every day you could be forgiven to thinking that lots of important stuff happens. But I think that, for 2013, there is only one newsworthy event, and that is:
“the US economy is recovering.
That fact alone will change the next decade and Australia is simply on the receiving end. So what does it mean?
We’ve already seen some impact on the A$ as it fell 10%+ on news that the US economy was improving. The reason is that, if the US economy improves, then QE will end sometime in the next few years, which means that US interest rates will rise. Already the markets are jockeying to position themselves ahead of higher interest rates.
That means some pain for China, as the equation of the last decade, with a low US$ fuelling Chinese exports, changes, suggesting lower China growth in future.
That also means a push for higher interest rates in Australia, yet paradoxically the Reserve Bank is aiming for lower rates, with the market expecting a further 0.25% reduction in the cash rate tomorrow.
Something has to give, and the something in this case is the exchange rate, which should trend down to US$0.90 or less.
So with lower interest rates, what is the outlook for real estate in Australia? Do we rush out and buy, or will negative economic conditions make it a risky decision?
“Never make forecasts, especially about the future
Remember Professor Keen and his forecasts of falling house prices over the past five years? In our major markets, prices are now above the 2008 GFC levels.
What about the election? I’m tempted to say that, whoever wins it will not make a big difference to our economy as it is external factors that will determine Australia’s course in the next decade.
So our outlook appears to be something like this:
A stronger US$ means a lower A$ trending down below US$0.90
In the short term, lower interest rates, but they will have to increase within a year or two as the US defines what interest rates are acceptable.
Although China slows, stronger US growth increases prices for base commodities, offsetting any Chinese weakness. So the trade position of Australia should remain relatively strong.
The Australian non-mining sectors will continue to under-perform, in short more of the same.
Unemployment levels may trend up a little but probably won’t rise by much more, say another 0.3% over the next year before steadying.
Overall, the outlook is fair and Australia should be able to adjust reasonably well to this new world. Our residential real estate prices are already at world highs, and while a price boom would be counter productive, there seems reason to expect present or slightly higher prices to continue, as real estate becomes an asset store of value rather than a growth play. All in all, a more comfortable outlook for Australia than might be deserved. We may afford fewer holidays abroad, than in the past, and inflation and interest rates will nudge upwards, but that is still a better outlook than for most of the developed world.
The value of the Australian dollar took a hammering overnight as we head down to US $0.91 and it looks like we will be entering the 80s very soon. Compared to the exchange rate of US$1.05 that we have been used to for a long time, we are starting to look at a depreciation of about 15%.
So we ask two questions, what does this mean for us, and how low can the exchange rate go?
The reason for the fall is the emerging strength of the US and overnight at the meeting of the Fed, they gave a stronger indication that they will scale back asset purchases in the next year, which is QE. This has scared the bond markets, which have got used to free money and are understandably not too happy at the thought of rising interest rates. But the upside is that the US dollar is back in favour as the safe currency of the world, which means that the aussie dollar is getting re-rated and moving back to a more realistic exchange rate, or so they tell us.
Our Reserve Bank wanted the exchange rate to fall, which is why our interest rates had been coming down. The reason was to stimulate the nonmining sectors of our economy, which have been uncompetitive at parity or above with the US dollar.
How low can our dollar go? It is widely believed that an exchange rate of about US$0.85 would be about right. But when changes happen, they can overshoot before getting back to a realistic level. Last time this happened, our dollar dropped into the 70s before returning but who knows this time?
Of course, we have got used to imports being ridiculously cheap. When Coles can import bread from Ireland cheaper than baking it here then you know that the world is crazy. Fortunately I saw this coming, so my holiday abroad, next month, was largely paid for earlier in the year. I have just bought a new car, the model that I also bought 10 years ago, and the price I paid last month was the same as 10 years ago. But prices are now going to increase significantly, as Gerry Harvey, that guardian of consumer welfare, helpfully pointed out at the beginning of the week. So if you want to make a large purchase of something imported, now is the time to rush out and do it.
So let’s deal with the economy first.
We will have to get used to paying more for our goods. This will put upward pressure on wages and inflation, but we will not get compensated for the change. The upside is that many of our domestic industries will become more competitive. Our major export industries of tourism and education will feel the benefits, and spending on domestic services will start to look more attractive. Our manufacturing sector will get a reprise, and maybe it will help the car industry a little.
Although the intent was to help the nonmining sector, paradoxically it is the mining sector that stands to benefit most. The panic of last month over iron ore prices is already receding as prices are rising in US dollar terms, and the fall in the exchange rate provides a handy 15% boost to the income of our mining companies.
In the last month, headlines had been about resource companies curtailing exploration, cancelling new projects and reducing the workforce. We are likely to see an abrupt about turn, as resource companies start to think about expansion again.
This will be good news for Western Australia in particular. In the last month, overblown worries about increasing unemployment and a recession have taken the headlines. Well a month is a long time in that State, and we are likely to see a return to growth and optimism as the economy continues to grow.
This will also play out in Queensland and the Northern Territory. Throw in a Federal election and the winds of change are blowing.
The risk is what all this will mean for China. With the Chinese economy starting to look like a dangerous balancing act, the rise in the US dollar will impact directly on Chinese exports. What affects China affects us, and how this mix will play out is anybody’s guess at the moment.
Assuming that China manages to get through this period, the impact of all these changes will probably be positive for Australia.
In terms of Australian real estate, commercial real estate is now looking 15% more attractive to overseas buyers, and we can look forward to increased interest at the prime end of the market.
Improvements in our economy, for Western Australia in particular, should translate into improved support for our residential markets. However this is no longer going to be driven by lower interest rates. Present rates have done their job in lowering the exchange rate, and once again the focus of the market will shift to speculation on when our interest rates will start increasing again. And increase they will. Somewhere in the next year interest rates in the US will start moving up and ours will have to follow. As the A$ goes out of favour bank funding costs will increase and our mortgage rates will have to reflect this. At this stage, we are not talking about dramatic changes in interest rates, but we should start thinking about increases of 50 basis points or 0.50% over the next year.
So welcome to the new Australian economy and the new normal.
So is Western Australia in a recession or not?
Recent newspaper headlines claimed that Western Australia has entered a sharp recession, but this has been followed by other articles claiming this is not the case. So what is happening?
See our full report below
The latest report by RPData shows as prices falling by 1.2% in May, following a fall of 0.5% in April. In the first quarter of this year, prices were reported as increasing by 2.8%.
In contrast to RP Data-Rismark figures on value changes, our valuers are seeing values continuing to rise in most of our major cities.
Overall we consider that prices have continued to increase at a moderate pace in most markets. The difference may be due to the RP Data-Rismark methodology whereby the index measure the change in imputed house and unit values based on the flow of sales data and the attributes of those homes.
See our full report below
The latest report by RPData shows as prices falling by 1.2% in May, following a fall of 0.5% in April. In the first quarter of this year, prices were reported by RPData as increasing by 2.8%.
However, this does not match the experience of Propell’s property valuers who operate in the markets, where most markets are seen as stronger than the RPData figures suggest. Overall we consider that prices have continued to increase at a moderate pace in most markets. The difference may be due to RPData methodology that reports on median prices, which are not the same as typical prices. A change in sales composition, e.g. a fall in the number of higher value sales, or an increase in the number of lower value sales, can change the median price, so that it is possible for the median price to fall, when values are actually increasing.
Click on the link below for the full report.
So is the world economy improving or not? A slew of optimistic news in past months is getting replaced by a series of negative news, confusion reigns and this has shown up in volatile markets around the world.
The UN issued a revised global economic forecast which was reduced to 2.3% from a previous 2.4%, the actual numbers matter less than the fact that the forecast has been lowered.
So in the USA jobs are being created and unemployment claims are coming in, on the low side. US home prices are rising, but according to an article in todays AFR:
“Financial data firm Markit said that in the United States, falling overseas demand and domestic belt-tightening pushed the US Manufacturing Purchasing Managers Index to a seven-month low of 51.9 in May from 52.1 the previous month. A reading above 50 indicates expansion.”
However the expansion is enough for Bernanke to start talk of a reduction and eventual reversal of QE in the future. Couched as it was in careful language, that was enough to send stock and bond markets into a panic.
The Japanese market had a one day fall of 7.3% as concerns about the new economic policy or “Abenomics” took hold, and Chinese manufacturing fell, with traders suddenly remembering that chinese debt had expanded from $9 Trillion to $23 Trillion and the government can’t keep pump priming the economy on debt forever.
If QE is wound back, and US interest rates start increasing, the worry is that the massive outflows of US capital in recent years to the BRICS countries, and Australia, will hit the brakes and come to a stop. It is exactly these circumstances that killed the developing economies before, such as the Asian Crisis of 1997.
It is hard to see an upside in global conditions for Australia. Potentially we face a mixture of declining exchange rate, increasing inflation, lower demand for mineral exports. It will probably be next year at the earliest before all this kicks in. Meanwhile our government keeps developing budget policy on the assumption that todays extraordinarily good economic climate will continue.
The domestic outlook for employment has taken some hits, with Ford announcing closure of manufacturing here, Swan cleaners dismissing all staff and while low interest rates might otherwise kick off a boom in house prices, Australians still have reason to be cautious. Our forward estimate for national house prices, as recently as a month ago, was for a 5.2% increase in the nezt year, but with the election, and a declining economy, we may see interest in the housing market fade after the September election and average price rises come back to about 4% for the next year.