Charlie Jamieson, Portfolio Manager and CIO
Jamieson Coote Bonds
The US Federal Reserve hit the brakes for first time in 13 years, policy is now economically ‘restrictive’
The US Federal Reserve (the Fed) lifted interest rates to 2.25% as was widely expected in September and commented that monetary policy is no longer ‘accommodative’. Previous rate hikes have merely lifted their foot from the accelerator, but moving from ‘accommodative’ to ‘restrictive’ is a significant moment in the development of the economic cycle, as the Fed is now actively trying to jam on the brakes. With interest rates rising and funding liquidity difficulties mounting, pressure is building on debtors. Historically this leads to recession as corporate/personal debt bubbles burst and financial defaults ensue. There is nothing in this set up that makes JCB believe this time will be any different. Looking at US interest rate moves over the past 75 years, a rise in interest rates has had a significant effect on risk assets. Since the Brexit lows, US Treasury bond yields have risen ~120% versus a cycle average of ~44%. Corresponding moves in US S&P equity indices after such moves have been negative (unsurprisingly as financial conditions tighten) with a mean drawdown of -20.2%.
US interest rates are rising and the Fed is intent on jamming on the brakes. JCB believes the asset allocation implications are likely to be vast.
The party has come to an abrupt halt for Australian property thanks to the Royal Commission and domestic credit availability
When you ’grow’ with debt, times feel good. Loans are made, capital is deployed, asset prices rise, interest is paid and everyone is happy. Until someone later in the cycle is denied a loan, at which point that ‘growth’ can flip to unsustainable debt loads very quickly. The Hayne Banking Royal Commission will likely be viewed in history as the tipping point for Australian financial asset and property performance. After a long period of easy credit availability globally, coupled with weak domestic loan due diligence and generous loan to valuation ratios, it seems the party has come to an abrupt halt for Australian property, with significant implications for Australian banks who are highly leveraged into property lending as their main source of income and profit growth. Other factors are also at play with APRA tightening its policies and global funding costs rising.
Property settlement failures could trigger dreaded forced selling; the seat belt sign is on
Ordinarily, to have a collapsing marketplace you would need ‘forced selling’, people who must transact regardless of economics. In a recession or high unemployment period these unfortunate folks are easy to identify, but in a silent correction – such as we are currently experiencing in Australian property – identifying the forced seller is much harder.
The tightening of bank lending on investment properties is having a significant ripple effect through the Australian apartment markets. ‘Off the plan’ buyers are failing to settle in droves on completion of their purchased apartments due to the lack of banking finance. Some estimates of completed apartment projects unable to settle in Brisbane, Sydney and Melbourne are running as high as 40-50%. Failing to settle a legally binding contract is no small problem, placing leveraged developers under financial strain who in turn are potentially forced to flip their newly finished stock into a falling market to satisfy their own loan agreements. The obvious chain of events from here could create a wave of forced sellers into a market that is only just beginning to correct after a period of vast outperformance. The developers have a contractual right to sue the buyer for the difference between the assets realisation (plus legal costs) and contract price. Should the purchaser not hold sufficient liquidity to fund such a cash settlement, they would be forced to sell assets. It shouldn’t take much of a correction for banks to revalue an investment property portfolio to the downside and materially tighten loan conditions or required additional capital calls. Buckle up, JCB believes there could be turbulence on the radar ahead.
AUD enjoys counter trend bounce, still bearish for now
The Australian dollar (AUD) enjoyed a brief counter trend bounce in September trading above 73 cents (versus the USD), before pulling back again into a negative trend. Ultimately, a mild fall in the AUD will help stabilise the economic fallout from the change of government combined with pockets of housing stress. JCB maintains that 2018 is the ‘year of the USD’ as the US enjoys the last throes of highly ‘pro-growth at any cost’ policies. As economic growth declines into 2019 and with Trump’s fiscal expansion moderating, the AUD currency will likely break its clean downward trend.
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