By Roger J Kerr
Finance Minister Bill English, in a series of meetings last week in the US, with the IMF, World Bank and credit rating agencies, came away with a message that highly leveraged property investors need to think about, but probably do not want to hear i.e. market interest rates are going no lower and the only way is up from here.
There have been many false dawns over the last seven years since the GFC regarding interest rates starting to rise off the bottom. But then the increases soon reverse back and we see new record lows.
So, what is different about late 2016 to the earlier false dawns of interest rate increases, you may well ask?
The debate today in economic and interest rate market circles around the globe is around the belated realisation that zero per cent interest rates are not working to stimulate consumer demand and spending.
The whole basis of monetary policy stimulus to an economy is under intense scrutiny and question.
It is not working in Europe and Japan, as consumers are more worried about deflation and pension fund viability caused by zero per cent interest rates.
The demographic bulge of baby-boomers are not spending in the stores as they were expected to be doing at this time because their investment incomes are decimated by the very low interest rates.
In New Zealand, baby boomer investment money has departed bank deposits as the interest yields were insufficient to fund lifestyles and moved into dividend stocks on the NZX.
For the first time in several years those new equity investors may be about to experience the downside to markets risk as the NZX market as a whole follows US share markets lower.
Political risk and upcoming increases in US short-term interest rates from the Fed are brewing as reasons for a significant correction down in the Dow Jones Index.
After the RBNZ cut the OCR to 1.75% in early November, borrowers may be looking into 2017 and contemplating higher long-term interest rates as US bond yields lift to above 2.00% and ultimately rising short-term interest rates later in 2017 as local inflation finally rids itself of oil price reductions in 2014 and 2015.
Two to three year swap rates have already priced-in the 0.25% OCR reduction next month. A lower OCR will make no difference to bank funding costs, so mortgage lending rates will remain unchanged on the RBNZ cut.
Despite the joys of spring, there may not be much to smile about for borrowers going forward unless they are heavily hedged with fixed rates.
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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
17 Comments
The whole question of whether a reduction in interest rates stimulates consumer demand and spending or not revolves around the marginal propensity to consume of borrowers versus lenders. The view of central banks like the RBA was that " the positive effect of lower interest rates on the disposable income of borrowing households is larger than the negative effect on the income of lender households". That is the marginal propensity to consume of borrowers is higher than lenders.
It must be nonsense, it seems to suggest that people with positive money assets will tend to spend less than people with negative money assets.
It only seems to work if you are want private debt to increase, but how long can the unsustainable be sustained?
Eloquently put Peri. Rog is on the money with this article.
If those of us who are debt free can see a relatively risk free bank deposit of 5/6% then we'll certainly feel more comfortable about going out and spending our hard earned. Alternatively, if we wanted to see a turbo charged consumption led recovery, the brains trusts here and elsewhere should've gifted every citizen $1,000 instead of rewarding the parasites on Wall Street. Where did that get us?
"It must be nonsense, it seems to suggest that people with positive money assets will tend to spend less than people with negative money assets."
I would think in this day and age it holds very true. How do you think people get positive money assets? It's not by spending.
This is accurate as anyone in debt has spent more than they've earnt. There are plenty of people that can't pay their credit card bill in full every month. So extending more credit by way of lower interest rates gets more consumption up to a point. Then there's the debt hangover that lasts for many years afterwards.
I was looking at the US underemployment figures on the train this morning and they are starting to look good. There's already inflation there but it looks close to the point where it will pick up more. The Fed will get their excuse to increase their OCR in the short term. That will affect us gradually.
What I'm not sure about is the ECB and BoJ. Japan seems intent on monetary suicide and the ECB seems to be stuck between a rock and a hard place.
What will happen when interest rates rise with so much debt?. I dont think as a society we can borrow anymore and if interest rates rise what happens to the rest of the economy?
For me the focus of the reserve bank solely on inflation without taking into account house price inflation and the increasing debt has been reckless.
Continued OCR cuts has led to the lowest interest rates in NZ. This has led to continued debt growth and our highest house prices way past the point of affordability in Auckland.
I believe that debt is the biggest threat to our economy and our economy is running out of the ability to pay debt and why at historic low interest rates we have no inflation. This is a sign we're in too much debt.
This borrowed money has driven us through the last years and peoples ability to afford this debt is because its become so cheap. Id like to see the treasury numbers if interest rates double.
When interest rates rise what will happen to this debt?What happens to our economy when house prices stop rising? Inflation will not be a problem. Its not a problem now with historic low interest rates.
Banks will not lower interest rates with the next OCR cut making the RB almost irrelevant. The banks are the shot callers now and hold these debts. Their lending policies have led to massive debt growth on the back of increased house prices. Their goal is to get the most profits from NZ even if the massive debt stifles the rest of the economy.
Low inflation is not the problem of the NZ economy it is the symptom of the massive debt that continues to grow.
"What will happen when interest rates rise with so much debt?"
Very good question indeed. I believe central banks cannot increase interest rates significantly. Imagine the OCR returning to 4% with resulting bank interest rates of 6.5%. It would plunge the country into recession, so many borrowers couldn't meet their payments, mortgagee sales would be ubiquitous plunging property values, this means people would really stop spending, cafés, restaurants, clothes shops, all retail shops, car dealers etc would suffer big time, resulting in bankrupcies and many many staff layoffs who would then themselves stop spending exacerbarating the problem... I thnk central banks cannot afford to raise interest rates past a token 0.25 to 0.50% and they know it
I thnk central banks cannot afford to raise interest rates past a token 0.25 to 0.50% and they know it
It's not their choice, global central banks have been following market rates down due to incessant recessionary forces. Nonetheless, banks will raise interest rates for the not so wealthy and in most cases prohibit them altogether from participating in the process of capitalising property at other's expense.
Yvil - were you around in the late 80's ? That's exactly what happened because it had to happen and it was done in the full knowledge that some people would be hurt, many badly. The fact is things can happen and those that suggest it can't for the reasons of wide spread pain are often those that are the most vunerable and relying upon it - don't be one of them.
The 1980's were a very different time. Interest rates were busy peaking at the top of the cycle, nothing to do with central banks. Being early in the currency cycle is very very different to late in the cycle, their is a much greater debt burden and very little room to move when things go bad. To repeat something I say often, we are in a 30 year downward trend in interest rates and nothing on the horizon looks to change that trend.
The growth in debt is what's keeping this housing bubble afloat. We are beyond the point of no return. Steve Keen demonstrates a mere slow-down in it's growth rate is all that is needed to cause a recession. This is a long video but a good explanation of where we, and many other developed economies, are at after 8 years of Central Bank mis-guided intervention. The main thing to note is that not even a contraction in credit is needed to collapse the system - just a slow-down in it's growth. This explains why the Key government are so reluctant to do anything about the demand side of housing. However, they are simply delaying the inevitable.
Also suggest reading this document from the Bank of England who seem to be one of the few CBs who have got their head around how banks create money/credit. Banks are not intermediaries between savers and borrowers which is still the songsheet that 99% of economists sing from and explains why we are in this mess.
I have read my last article by this guy.I am truly sorry for those who might actually pay for his services.
For months now,he has been berating the RB for not cutting rates more aggressively,while those with sufficiently long memories will recall when he was adamant that cutting rates would unleash a torrent of imported inflation. Frankly,he's clueless.
New figures from the US..the 1/4% interest hike a few months ago has caused mortgage applications there to drop by 6%. The overleveraged property owners in NZ are heading for trouble which will affect the whole NZ economy and the stability of the banking system once interest rates rise. Look for the NZ$ to depreciate significantly as the reality of ridiculous Auckland property sets in with loans to people who can barely afford them now let alone once interest rates start rising and they have to re-finance. If you have US$'s, Short the NZ$ with everything you have, then scoop up the NZ property bargains once the defaulted properties hit the market and rent back to the people that lost their homes.
This is what the RBNZ policies will cause.
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