More evidence the RBA should not hike in October

Based on our assessment of the current settings in the Australian economy, based on our assessment of the pressure under which Australian households are labouring and based on our assessment of where global growth is going we believe it is inappropriate for the RBA to hike interest rates in October.  Today's credit data and housing price data shows just under what pressure the Australian consumer/household sector is under at the minute. There is no doubt that there is a crash in demand for housing finance which, as a proxy for physical housing demand, will ultimately help prices adjust lower due to falling demand and with Australian household wealth flatlining, as noted by the RBA in the Financial Stability review today, this weakness is a really important counter balance to the mining boom.

We feel strongly that the operation of the RBA in September was a talkfest aimed at redressing an imbalance of expectations which saw markets pricing a rate cut to an outlook that better reflect their ongoing tightening bias.

We believe that in a rush to ensure that they get their point forecast right on the next RBA’s meeting that market pundits have let themselves be deceived by their own rhetoric rather than that of the RBA. Specifically in Governor Stevens speech of September 20^th he said the following:

“Often, the expectation of what will happen to the cash rate in the future is just as important as, or even more important than, the level of the cash rate today. For this reason what the Bank says – or what people think we have said – can be very influential on markets and behaviour. It is for this reason that central bankers are usually so guarded in public comments.” Our bolding.

That is we, the RBA, jaw bone sometimes. That is what we think has happened over the last month.

We do appear to be in the minority however  suggesting the RBA should and will leave rates where they are next Tuesday given we think there is much pressure on the economy already.  Now, we have often said we believe that the RBA is the best central bank in the world and with two decades of uninterrupted growth in the Australian economy there is much evidence to support this. But they are not infallible and if they hike we simply believe it increases the chances that rates will be lowered in late 2011.  The AUD is pushing hard on the top of a really strong uptrend. We like it higher eventually but we might be seeing the top for this run.

Currency War - Bullets now being fired

We seriously believe that US policy makers are getting it wrong to assert that China is a currency manipulator as a way to force them let the Yuan float a little bit closer to where they, US Politicians, believe it should be. Belligerence is a  trait that Chairman Mao inculcated in his cadre and the US approach is likely to escalate tensions further. Already the Chinese have retaliated with a ludicrous set of tariffs on US Chicken imports claiming that these are being "dumped" on China.

Now we admit that this could be a cunning plan by Legislators to drive up the cost of Chinese imports into the US and give the United States a little bit of inflation at a time when deflation is clearly a risk but we doubt they'd be so prescient. Rather we think the up-coming mid-terms, thin slicing and downright irrationality is behind this move.
CNN reports:

"If this risks upsetting the People's Republic of China, so be it," said Ohio Democrat Tim Ryan. "Whether you're a Democrat or a Republican, a liberal or a conservative -- millions of good-paying jobs have been lost and hundreds of thousands of families across this country have suffered as a result of China's unlawful trade policies."

Yeah yeah, right. It was the Chinese desire to steal American jobs not the corporations desire for bigger margins that drove them into either Chinese production or Chinese sourcing and as such drove jobs offshore. American consumers simply learnt the lesson that their corporate leaders wanted them to and that was buy more and more of the cheaper goods that China made and Chinese manufacturers simply learnt the lessons that they were taught.

China's currency would probably appreciate if it was freely floating but to what end. This would quickly reprice Chinese exports cause massive job losses and most likely cause serious social unrest. Remember that at Chinese New Year a couple of years ago 20 million Chinese went back to the country side for the celebration and did not return to work. The Chinese Politburo knows that in Chinese history unrest in the lower socio-economic ranks often causes regime change. Something they would have to fight hard. So it's in China's long run best interest to open gradually and let the Yuan appreciate over a longer period.

The US wants the Chinese currency higher, the Japanese want their currency weaker, the British won't want Sterling's run to extent too much further nor the German's the Euro's move. Brazil won't want the real to move too much higher against the USD either. Competitive devaluations and trade wars loom large as a big risk to the global economy.

CNN on the US Law
http://money.cnn.com/2010/09/29/news/economy/congress_china_currency_bill/index.htm?section=money_latest&utm_source=twitterfeed&utm_medium=twitter

FT Alphacville on the "Fowl" Tariffs
http://ftalphaville.ft.com/blog/2010/09/29/355836/irony-alert-china-cries-fowl/

The RBA should not hike rates in October - how much can a household bear?

Punditry is an interesting art form insofar as the question of whether the pundit is saying what s/he thinks or simply saying what they think will be well received. So it is with economic pundits and their call for RBA moves next week. We have read at least one prominent economist who clearly doesn’t believe the RBA should increase but thinks they will so that’s their call. In a sense they are trying to be right on “both hands”. That’s fair enough, it’s what keeps them employed in the long run probably, safety of the pack is better than being caught one out trying to defend a position.

We are in the camp that says the RBA should not hike next week. We know they have held a bias to tighten for some time and have spruiked it in this piece often but we truly doubt that Households need another reminder of the impact of interest rates to remain circumspect.

Source: ABS, Spotlight
Look at the chart. Does this look like a housing bubble. Would Minsky think this was Ponzi? We doubt it. Yes Australian house prices have risen and yes Australian debt levels are high but the household sector is circumspect not ebullient. That's for markets.

It is quite clear that the recent commentary from the RBA on the outlook for Australia and the positive impacts that we are expected to encounter from the 2 leg of the mining boom is driving the rationale behind the call for rate hikes. We also understand, and the RBA has made quite clear, that is the Household sectors that must be contained in order to make room for the mining boom so as not to create capacity constraints which would fuel inflation. But how much can Households bear?

The Housing Industry Association released their new home sales figures for August yesterday showing a fall of 2.6% which was a fourth straight monthly decline. Sales have now fallen 18% since their recent peak in January and are down over 20% since the same time last year. Housing finance has followed a similar path with approvals for owner occupiers contracting at an annual pace of 20% over the past few months while approvals for investors are also pulling back sharply. We have talked about the natural handbrake on activity that is the AUD heading toward parity and we believe the global backdrop still fragile.

So with Household already feeling the pinch and the AUD on the up the RBA may have a little more time up its sleeve to resume the tightening cycle

Currency Wars - reprise

A week or so ago, maybe two weeks we posterd our thoughts on the looming cvurrency wars as the new smmot-hawley front of 2010. It seems since then that this view has gained traction and we are seeing talk of currency wars all over the place. The latest area of interest has been Brazil where the Finance Minister Guido Mantegna warned that “international currency war” has broken out, as governments around the globe compete to lower their exchange rates to boost competitiveness.".

This is a massive risk to the status quo of international trade and we posted our thoughts back in the middle of the month here. (http://spotlight-onmarketsandeconomics.blogspot.com/2010/09/currency-wars-is-protectionism-about-to.html).

The key point is that now that everyone ios doing it then by definition it must be ok, even you national duty, to do it. So watch out for Brazil to be the next cab off the rank.

Australia seems to be the only jurisdiction not concerned by its currency and not withstanding the fact that the AUD/USD is at the top of its trading channel and may pullback this alone means it stands out amongst a world where currency weakness is preferred as a buy.

Here is an article on the Brazilian question from FT Alphaville. http://ftalphaville.ft.com/blog/2010/09/28/354321/currency-wars-sound-bite-of-the-week/

Bernanke on implications for Economics of the Crisis - its no clearer

Markets are fabulously egalitarian. They make fools of all of us at some point. The last three years are a case study in this regard. Banks who were considered industry leaders were bought to their knees, sometimes just bought. Companies in the business of insurance were found to be insuring risks they didn't understand and couldn't hedge. Central bankers prescience lost its crystal ball and the great moderation has turned into the Great Recession.  The foundations of modern finance have been shaken to the core. 

If nothing the equanimity of the embarrassment to all of us who have sought to make predictions has taught us that we know less than we pretended to. The number of times many have felt  Rooster, Feather duster, Rooster , Feather duster as the market has ebbed an flowed and short term fluctuations, because of impatience and uncertainty, have been extrapolated into medium and long term trends only to reverse within days or weeks. 

So it was that we were a little surprised that on Friday night Chairman Bernanke launched a defense of economics after the crisis and the role central bankers and the economics profession played. To our mind the core message of his speech was effectively that the economics profession couldn't ever predict a bubble but centuries of economic study gave them the tools to deal with the crisis. So that's ok. Right? The second part of this is true and Bernanke specifically spoke of the lessons of Bagehot more than 100 years ago. But Bernanke also spoke of more analysis necessary on the study of financial instability.

We'd like to point him to the work of Hyman Minsky which to our reading has at its core solid economic analysis, has built on the lessons of Keynes and has behavioural insights before we knew that we needed any. We really were disappointed in this speech because it let too many people, both academic and commenteriat,  off the hook. The unfortunate reality is that the outlook is still confused as the divergence between 2, 10 and 30 year Treasuries and the equity market shows. How can the equity market and Treasury traders both be right? They simply can't.

We may have learnt many lessons from the last few years and may have many more to learn but the equanimity of the market hasn't changed. Either US equity or interest rate traders are going to be disappointed eventually. The voting machine says equities are right but the weighing machine is with bonds. Rooster or feather duster?.

http://www.federalreserve.gov/newsevents/speech/bernanke20100924a.pdf

Flash Crash Trash Traders - going the the way of the Dinosaurs?

The flash crash back on May 6th was a wake up call to average investors that both the stockmarket isn't a money tree in the back yard and that, to a certain extent, the market was now rigged in favour of the so-called High Frequenct Traders (HFT) who use computing power to scalp their way through the market each day and take miniscule points almost at the speed of light which add up to decent amounts at the end of each day. These traders are no different to the scalpers outside your favourite sporting fixture or concert and as such add nothing to its efficiency or effectiveness of helping the stock market it do its job.

On the other hand some say HFT provide liquidity. We'd say they distort the market in the best modern example of Gresham's law in modern finance. That is, bad money drives out good. Now obviously the HFT believe they have a role to play but Andrew Haldane (yes again) summed them up really well recently in his speech "Patience in Finance) saying:

On 6 May 2010, the price of more than 200 securities fell by over 50% between 2.00pm and 2.45pm.32 At 2.47pm, Accenture shares traded for around 7 seconds at a price of 1 cent, a loss of market value close to 100%. No significant economic or political news was releasedduring this period.

"While HFTs are not new, their speed of execution has undergone a quantum leap. A decade ago, the execution interval for HFTs was seconds. Advances in technology mean today’s HFTs operate in milli- or microseconds. Tomorrow’s may operate in nano-seconds.

HFTs operate in size as well at speed. HFT firms are believed to account for more than 70% of all trading volume in US equities, 40% of volumes in US futures and 20% of volumes in US options. In Europe, HFTs account for around 30–40% of volumes in equities and futures. These fractions have risen from single figures as recently as a few years ago. And they look set to continue to rise.

Asian is not immune from these trends. HFT is believed to account for between 5 and 10% of Asian equity volumes. In China, HFT is still in its infancy. But market contacts suggest as much as 80–90% of trading on the Shanghai stock exchange may be done by day-traders, many small retail investors. Impatience is socially, as well as technologically, contagious.

This evolution of trading appears already to have had an effect on financial market dynamics.

The causes and consequences of this “flash crash” are no clearer now than at the time. But it is known that a number of large HFT trading positions coincided with these chaotic dynamics. In response, market-makers and liquidity-providers withdrew. Gresham’s Law re-emerged as bad money drove out good, its effects now taking milli-seconds rather than months. Trading in securities generated trading insecurities. The impatient world was found, under stress, to be an uncertain and fragile one."

Writing in "Zero Hedge" blogger "Tyler Durden" refers to an article from the FT about the slowdown in trading which this month seems headed for a new three year low.

Source: Bloomberg, Spotlight. Idea: FT and Zero Hedge

We'd been careful of calling the article "placed" but it seems to us it is slanted toward supporting brokers who have been transacting for HFT and who are lamenting the lowering in volume from the HFT sector. Specifically the article says;

"Diego Perfumo, an analyst at Equity Research Desk, said that efforts by global regulators following the May “flash crash” were reducing volumes by high-speed firms, which was making it more difficult for other investors to trade.

“Higher trading scrutiny combined with tighter regulation is drying up the liquidity provided by high- frequency traders. Lower liquidity is symbiotically affecting volumes from traditional investors,” he said."

We'd argue that the correlation runs the other way. Having seen the flash crash "real" investiors and speculators now know they can't just trade on fundamentals or even technicals intra day but rather the market will move with volume that no system available to them can predict. Thus they are not playing and providing the trade flow for HFT to scalp.

We hope that market volume slows enough to put these HFT out of business. If legislators won't do it then perhaps the market can regulate itself afterall. Perhaps time has really speed up such that flash crash trash HFT will have the shortest half life of any financial innovation and go the way of the dinosaur.

FT Article that kicked this off
 http://www.ft.com/cms/s/0/81de5a8e-c731-11df-aeb1-00144feab49a.html

Zero Hedge article that prompted this Blog
 http://www.zerohedge.com/article/further-confirmation-irrelevance-stock-markets?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29

Andrew Haldanes Speech http://www.bis.org/review/r100909e.pdf

Thoughts and Links 24/10/2010

 5 New traits of the American Consumer
At spotlight we have a definate Behaviuoral bent to our assumptions about economies and marketes and what drives them. We don't believe in models of consumer thought or behaviour but rather how a given set of circumstances may impact on that behaviour.

So it is that we find this article really interesting in what it says about American consumers. It would also naturally inform the choice of companies in an equity portfolio. you can see where Apple would fit into a portfolio and why it has done well even in a poor economic environment.

"Here are five traits that define the today's consumer--and how companies can appeal to them
Optimism. Consumers that Gerzema and D'Antonio classify as "spend shifters"--55 percent of Americans, based on their research--are optimistic and resilient...they simply seek value for their money.

Brand consciousness...they're often drawn to brands known for providing value.

Authenticity-seekers..." a desire for a more ethical and sustainable approach to consumption--and life," the authors write.

Purpose-driven. "consumerism needs to be tempered by a thoughtful awareness of its negative social and personal implications," ...research found that most respondents enjoyed cutting back and decluttering their homes.

Mature...Compared with their parents and grandparents, twentysomethings are "even more focused on achieving their goals and attaining their dreams,"

These five shifts represent some big changes from the heady days of the previous decade, where credit was easy and consumers seemed to always want bigger cars and bigger homes. Now, companies have to come up with creative answers to the question: How do you market to consumers who aren't as fond of consuming?

Full article here http://finance.yahoo.com/news/5-Traits-of-the-New-American-usnews-1089751453.html?x=0

Sovereign Debt
The Euroipean periphery are, once again, under pressure from their debt burden and weak economies. Ireland is a case in point with the terribly weak GDP result overnight (-1.2% qoq) adding to its woes and making it 11 from 12 recent quarters of falls. The chart below shows that GDP is down more than 12% from the high.

The EUR/USD exchange rate finally pulled back overnight on this and the weak PMI result and we can't help but think that for all the United States economic problems now the real value of the EUR is about 1:1 to the USD. Sure DEM/USD might be different but Europe is more than just Germany and currency traders will wake to this eventually. Won't they?

Here is an interesting article on Ireland, but its really more about Europe and US banking debt. The US looks ok on this analysis. http://economics21.org/commentary/real-lesson-about-irish-austerity-plan

The debt problems of NATO countries particulalry the European ones overhang markets and growth like the Sword of Damocles. We hope that Ireland in 2010 is not the precursor it was in the Northern Summer of 2008.

So it is going to be interesting to see the Spanish Budget later today. Austerians reign supreme and it looks like Finance Minister Salgad will have to join the club. More Austerity means further weakness in growth for the region in the short term we'd guess.
http://www.bloomberg.com/news/2010-09-23/spain-faces-pressure-to-keep-up-austerity-as-euro-s-periphery-bonds-drop.html

Market Forecasting
It's a mugs game trying to forecast markets day in and day out. But it is particularly hard if, as in increasingly the case, you are the type of pundit who is as much a part of the marketing team as the markets team. So its not fair that Mark Zandi of Moodys has been targetted in this way but it is compelling to see just what being on the record can do to your record.
http://www.ritholtz.com/blog/2010/09/zandi/

For the record we used to do this type of stuff for a living and while we know how difficult it is to get it right we are not letting him off. Good economists and strategists need to look through the noise of the daily number or the media cycle and deeply understand the drivers of their markets and the theoretical and actual underpinnings of those markets. too many pundits thin slice and chase headlines rendering them talking heads.

The Junk Bond Bubble

We mentioned the other day that we reckon the Junk Bond market and the levels at which these credits are trading are a bubble that is an unintended consequence of the easy money policy that exists in the North Atlantic economies at the moment. We think this will inevitably end in tears.

This week NBER told us something we didn't need to know at a time when there are serious concerns about the next leg lower in the US. In this little blog from Buttonwood they look at both equities and payouts and, at the end, the length of US cycles. the key point for us is the following:

"if we have reached the end-game of the debt super-cycle, then recessions will be more frequent. The last recession started in December 2007; if the cycle is 56 months, the next one is thus due in August 2012, less than two years away. Such short, sharp shocks make high-yield bonds look a very bad investment. The asset category changed in character during the great moderation; junk bonds used to be investment grade bonds gone bad, but after the mid-1980s, companies issued primary debt at junk yields. An economic cycle that lasts almost nine years gives investors a chance to earn their yield and get out before the bust; a cycle that lasts less than five years makes that much more difficult."

Investors are lapping these things up because they think they will beat the cycle. Certainly easy money makes it easier to finance and rollover debt so, to a certain extent, forestalling and financial difficulties but in the end its about demand and earnings. As we muddle through the recovery and as its chances to morph into another dip grow so the Junk Bond market looks more and more like an asset class to avoid.

Here is the link to the Buttonwood Blog http://www.economist.com/blogs/buttonwood/2010/09/real_returns_and_dividends

Central Bankers are just people too...and like many they are confused.

We always treated the reverence with which markets and politicians afforded Chairman Alan Greenspan as something that was misplaced at a minimum and sycophantic if we were realistic. That may sound harsh but the cynic in us suggests that Greenspan was revered on the basis of a correlation in his reign with economic moderation as opposed to a causality in his reign with the great moderation. Nassim Taleb always wonders if a traders or fund manager are just lucky no matter how hot or long their streak is and even though we think that we are pretty good at market timing, in a macro sense, we share this view of the true nature of success. That is in extremestan luck plays a big role in results.

So we find it instructive that Central Bankers around the North Atlantic who were waxing lyrical about the improvements in their economies and wondering about policy and stimulus withdrawal are now figuring out what to do when monetary policy is at its nominal lower bound. We think the unintended consequences of easy policy is a prolonged economic malaise so this latest redux toward quantitative easing seems to likely to reignite fears in consumers minds and usher in a renewed period of restraint. If that is truly possible.

This is all a round about way of saying we think that politicians and market participants often forget that Central Bankers are people too. We are not aware of any special behavioral research on the nature of central bankers but we'd always guessed they always try to tell the truth and be honest and upfront. Except that Chairman Greenspan told us that's not true in his Biography a few years ago and Chairman Bernanke confirmed this recently before Congress. We understand why but what they seem to be doing alternatively is persuading us to either spend more than we should  or can really afford (remember Greenspan lauding mortgage equity redraw in a 2002 speech) or restrain our spending from where it could be in order to restrain growth overall. Nobel pursuits no doubt but less than honest nonetheless. The individual is a mere pawn in the macro-economic game of Chess.

So it is interesting to watch the current problems central bankers are having with where economies and markets are now. Their sales job of early 2010 have been found to be just that. their credibility on economic soothsaying is now in question (anyone remember Tim Geithner's cheerleading article a month or so ago) and so markets as well as consumers are losing faith.

Markets over the past 20 or more years have really relied on the notion of the prescience of central bankers. Now that everyone knows they are human the question has to be where to now?

Here is an article from Bloomberg discussing this very point.
http://www.bloomberg.com/news/2010-09-22/central-banks-have-trouble-finding-exit-from-stimulus-as-recovery-weakens.html

Thoughts and Links 23/10/2010

Larry Summers
We always wondered over the choice of Larry Summers as one of President Obama key economic advisers. Certainly for a Washington neophyte however Summers offered Obama a way in as he understood the corridors and knew his way around having been Treasury Secretary for President Clinton. Now he's gone and many in the United States are not unhappy with this. Here is a piece from our favourite blogger Barry Ritholtz
http://www.ritholtz.com/blog/2010/09/summers-good-riddance/

Currencies
Paul Krugman looks at the Yen in this NYT Blog. The point is that you can see why the BOJ and the Government don't want the Yen to strengthen. We think the Yen is worth closer to 100 on fundamentals but in its favour, and perhaps why it is so strong, is the fact that Japan has muddled through without crashing for well over a decade. It is not clear either the US or Europe will be able to have such a benign malaise. So the Yen, counter-intuitively, rallies. Markets are hard work sometimes.
http://krugman.blogs.nytimes.com/2010/09/22/about-the-yen/

This is what Krugman is talking about with his comment on the Chinese Exchange rate in the first stanza. Reuters via Business Spectator in Australia. http://www.businessspectator.com.au/bs.nsf/Article/UPDATE-1-US-House-panel-votes-Friday-on-China-curr-9JQNF?OpenDocument&src=hp11 China is not going to let its currency go just to please the Americans. They are opening slowly and we think doing it the right and patient way.

But the Americans do not. We understand that and have sympathy with their view from their perspective. But from a global and Chinese perspective we favour a modest appreciation in the Yuan rather than a free float. We fear however as the rhetoric is ramped up and tensions flare currency wars may erupt. http://www.ft.com/cms/s/0/769fdef4-c6a0-11df-8a9f-00144feab49a.html?ftcamp=rss

Interest Rates and Economics
Rates in Australia are definetely heading higher, eventually. Whether or n ot it is in October is open to debate. but one of our Big Banks, CBA, now thinks rates in Australia are going to 6% next year. We don't care how well the Mining Boom is going this will cripple households and retail. Business owners in the consumer section need to be very careful with inventory. http://www.theaustralian.com.au/business/markets/commonwealth-bank-forecasts-rba-to-lift-interest-rates-to-6pc-in-2011/story-e6frg926-1225928320700?from=public_rss

But elsewhere around the World Central Bankers are struggling with the opposite problem. This article goes to our blog on the unintended consequences of easy money (below http://spotlight-onmarketsandeconomics.blogspot.com/2010/09/unintended-consequences-of-easy-money.html ). We still have years of this to go unfortunately. http://www.bloomberg.com/news/2010-09-22/central-banks-have-trouble-finding-exit-from-stimulus-as-recovery-weakens.html

Dinomaniacs
Our young bloke loves dinosaurs. Most young boys seem to so hers something for the parents. Two new dinosaurs like triceretops but one has 15 horns on its head. The link has a couple of pictures. Cool!
http://online.wsj.com/article/SB10001424052748703860104575507942544136732.html?mod=e2tw

Martin Wolf on China - The RBA is right

Martin Wolf is the worlds best financial journalist. He is prescient, easy to read and shines a light on market or conventional wisdom and orthodoxy when required. In last nights article in the FT he is looking at Chinese growth. There are concerns over Chinese growth b ut we don't buy them. We think that China has a great balance of the USA and the USSR. That is free markets and a planned economy. We think this will underpin growth here, now and in the future and while there are substantial challenges for the future they are some years off.

The subrtext of the Wolf article is that it agrees with the underlying premise of the RBA. That is that the growth engince is still strong and has some years and way to go. It reinforces the long term strength of the AUD/USD exchange and cross rates, underpins employment and for the naysayers will underpin the property market via this linkage.

http://www.ft.com/cms/s/0/a1df57c0-c5b5-11df-ab48-00144feab49a.html?ftcamp=rss&ftcamp=crm/email/2010922/nbe/MartinWolf/product

Apologies if a subscription is needed - but its worth it.

Is the RBA really going to tighten in October?

The Australian economy is both a relative and absolute oasis amongst the G10 economies at the moment and there is nothing on the horizon that seems likely to threaten this reality. Certainly the RBA has been telling us for months now, probably longer, that they believe in the China/India story and that this will underwrite mining and investment for many years to come.

Over the past weeks we have heard first from Phil Lowe and this week Governor Stevens. We truly believe that the RBA is the best Central Bank in the world given that Australia is in its 20th year of uniterrupted growth without a recession. Given that we have a small open economy with few material trade barriers an exchange rate against the USD that has moved through a range of .4775 in 2001 to .9800 a couple years back to .6000 in the depths of the GFC and now sits at almost .9600. Also we believe their strength lies in the fact that they are comfortable intervening outside their inflation mandate when necessary.

So it is great when the world's best Central Banker at the world's best Central Bank is so frank with his thoughts. Such was the case two days ago when Glenn Stevens addressed the Foodbowl Unlimited Forum Business Luncheon in Shepparton. Governor Stevens did not hide his obvious feeling that things are looking up around Asia saying "The global economy continues to present a mixed picture. In the Asian region, most countries have well and truly recovered from a downturn that occurred in late 2008 and the first few months of 2009. The main exception is Japan. In the bulk of cases, economies are much closer to their potential output paths now than they were a year ago and policies are moving to less expansionary settings."

He was less upbeat about the overall picture in the developed advanced economies calling the outlook "uncertain". But Australia is doing well, "In Australia, growth has been quite solid over the past year, unemployment is relatively low, and inflation has, for the moment, declined. In fact, growth trends have been favourable over several years now in comparison with many other economies."

Markets got all excited and futures and swaps sold off on the strength of Steven's comments particularly where he said "Even with continued caution by households, that probably means that overall growth, which has been at about trend over the past year, will increase in 2011 to something above trend. We think that means that the fall in inflation over the past two years won’t go much further." 

A paragraph later though was where the sting was in the tail for households and market economists when he said, of offshore weakness "But if downside possibilities do not materialise, the task ahead is likely to be one of managing a fairly robust upswing. Part of that task will, clearly, fall to monetary policy."  Pharos emphasis all the way above.

These comments are clearly code for we've been on hold but we still have a tightening bias. We've only been blogging for a couple of weeks but is this really a revelation. Writing in our day job each day we have been reiterating this for months now and believe they have been consistently clear that this is the case. Yesterday's minutes to the recent RBA meeting were not as aggressive and pundits believe that the "new" infomation since then in the GDP release must be the reason for the heightened rhetoric.


But we are not so sure that the RBA hasn't just sought to move market expectations back onto to a more reasonable footing after they (markets) were forecasting a cut sometime this year only a few short weeks ago.  But do they really mean a tightening is imminent in October? Clearly a few big Bank economists think so with the NAB and WBC now looking for a rate hike next month. This is really no surprise but 3 year swap traders have pushed rates up 70 basis points in less than a month, no small move. Clearly after Phil Lowes bullish long term speech last week and now Governor Steven's outlook it seems the RBA was uncomfortable with market pricing. Rate markets now better reflect their reality we think but we're not sure October is locked in loaded.

Thoughts and links 20/09/2010

US Fed
Central Bankers really don't like deflation or its threat because of the impact it has on behaviours in the economy and the chances of a Japanese style lost decade/s. James Bullard from the St Louis Fed wrote a cracking piece about the risks and what needed to be done a few weeks ago (link here http://research.stlouisfed.org/publications/review/10/09/Bullard.pdf ) and it seems the FOMC is listening and readying itself to implement his plan.

Certainly Quantitative Easing (QE) is the new buzz around markets as the Federal Reserve has left the way open to buying US Treasuries. Overnight US Treasuries rallied and, we think, will rally further equities can be underpinned by a lower hurdle rate but ultimately they'll get undermined by a lack of aggregate demand in the economy while gold and other commodities and commodity currencies (AUD specifically) will rise with concerns over the debasement of the USD. We don't necessarilly buy the argument of the debasement of the USD. In fact we disagree but the short term market reaction was for a weaker USD.

Personally we doubt QE will work given that unless we can get Americans off the unemployment queues and, more specifically, banks doing their job of financial intermediation (rather than financial hoarding) the best the United States can do for a few years more is muddle through. In Britain they have QE, inflation

FT Alphaville has some comments on what has emerged in the 4 short hours since the statement this morning. http://ftalphaville.ft.com/blog/2010/09/21/348846/fomc-follow-up/

The problem of excess saving - FT Alphaville
Here is an example of why the Fed is looking for a little inlfation http://ftalphaville.ft.com/blog/2010/09/21/347606/the-problem-of-excess-savings/

Steve Keen's take on de-leveraging...very wonkish so something for the economics minded.
http://www.debtdeflation.com/blogs/2010/09/20/deleveraging-with-a-twist/

Robert Shiller - 7 more bad years?
Robert Shiller is one of our favourite economists. For those of us with a Miniskyesq and behavioural bent he is the closest thing we can get to a behavioural macro-economist. Shiller is Professor of Economics at Yale University and co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism. You should read "Animal Spirits" it is a great book for those who want to understand how the economy really works rather than how it is "supposed" to work. For example "Our bookmarks a break with tradition. in our view economic theory should be derived not from the minimal deviations of from the sytem of Adam Smith but rather from the deviations that actually do occur and that can be observed."

In this link he talks about the recent work by Carmen and Vincent Reinhart which build on Carmen's work with Ken Rogoff. Basically all of this work tells us there a re few years to go. http://www.project-syndicate.org/commentary/shiller73/English

Long Term V Short Term Investing

Andrew Haldanes speech (Patience and Finance)mentioned last week is a fertile ground for many thoughts, articles and blogs about finance, markets, economics and the growing need for instant gratification that we humans seem increasingly to desire.

We believe passionately in matching your investment or trading strategy to you goals, time frame and the market you are in. We think that mismatched timing and time frames is often the cause of traders being stopped out and investors being wiped out, often by margin calls. All too often we hear tales of I was right but got cut. That's no fun and in fact is debilitating in that it leads to second guessing yourself and a downward investment/trading spiral

We all trade and invest to make money but often our emotions can get in the way as Daniel Kahneman and Amos Tversky, amongst others, showed so well. And so it is that re-reading Andrew Haldane's speech we are struck by the point he made on "hyperbolic discounting" (which is the fact that peoples preferences alter as distant outcomes become closer to the present) that as time truncates people can exhibit preference reversals.

Anyway, Haldane says "the implications of such behaviour are far reaching. The patient planner becomes a spontaneous doer when outcomes are within reach...the long term investor becomes a short term speculator if assets can be cashed. As temptation beckons, the devil on one shoulder whispers more seductively on the other. Preferences switch as the distant becomes instant."

That is often the methodical process which built up substantial investment positions should not be replaced with an aggressive on market approach once retirement beckons or people start managing their own investments. Leverage, whether equities, FX or MIS are other examples where proximity (or perhaps just the positions) changes behaviour.

We have seen many examples of exactly what Haldane says over the years and certain investment strategies that blew up in the GFC are cases in point.

We don't want to sound like anyone's mum or dad but one of our core tenets is to make money slowly and keep it. That's not to say we are passive but we do have a plan. So think about your goals prior to investing that way you and your planner/adviser can then talk about options, strategies and set-ups. Then you can move forward together.

Thoughts and links - 21/09/2010

It took the NBER a year to tell us that the US was in recession and now, in September 2010, they tell us that the recession ended in June 2009. We know that recession timing by their method is an art not a science but is this really relevant. was it really a sustainable catalyst for equities to rally and risk to go on overnight. Given all the data we have seen since june 2009 and the growing debate about the potential for a double dip we think not, but its a great excuse for short term moves.

Here is a link to the WSJ which "compare the just-ended recession to previous downturns in GDP, private payrolls and retail sales" The market is a voting machine at the moment but for those interested in the longer term these are instructive. http://blogs.wsj.com/economics/2010/09/20/chartbook-the-depth-of-the-downturn/?mod=e2tw

Here is FT Alphavilles view on taking stock of the recession. As a sneak preview they say " The recovery since June 2009 could be called the “Great Disappointment”. After both the 1973-75 and 1981-82 recessions, output took only three quarters to exceed its previous peak. After four quarters this time it is still 1.3 per cent below its level at the end of 2007." Similar to the charts above but with words. http://www.ft.com/cms/s/0/e1fea3ce-c4ed-11df-9134-00144feab49a.html?ftcamp=rss

The AUD looks really goods at the moment. Yesterday we noted that we can forget Parity and aim at 1.10 on the USD but significantly higher on EUR, CHF and CHF. RBA Governor Stevens speech yesterday on top of Phil Llowes longer term bullish speech last week tells us the RBA is really bullish on Australian growth and interest rates are still biased higher. Currencies are an ugly sister contest but the AUD and the Australian economy is truly beautiful. Add to this everyone things AUD should go down and we reckon the risk is up. Heres the link to Stevens speech http://www.rba.gov.au/speeches/2010/sp-gov-200910.html

Here's the currency counter argument. PPP again as per yesterday. http://www.abc.net.au/news/stories/2010/09/20/3016864.htm

if its not currency wars its competitive QE. The Economist's Buttonwood Blog has a look at what's going on in the world of quantative easing.
http://www.economist.com/blogs/buttonwood/2010/09/currencies_monetary_policy_and_economy

Unintended Consequences of Easy Money

In response to the fall of Lehman Bros., almost fall of AIG and the financial crisis that this created Governments and Central Banks all over the World put the global economy into triage and slashed official interest rates, guaranteed their banking systems, guaranteed their banks and manned the fiscal pump. After a period of intense pressure and 6 months of concerns that the global economy was headed for a depression these policy measures combined with a pessimistic crescendo of selling into early March 2009 saw the equity market bounce and with it confidence, industrial production and the outlook for the economy.

This initial bounce seems to have run its course and Equities have struglled for 4 months now. So with the European periphery still struggling under the weight of Sovereign and Banking debts and with the US running a 40% chance of a double dip, according to Nouriel Roubini, we are concerned about both what governments and central bankers can do to further buttress their economies and financial systems and what the unintended consequences of the current policy settings may be longer term.

It is clear that low interest rates around the world are supposed to help kick start the economies by making it cheaper for companies to borrow to invest and, ultimately, to encourage savers to spend. But unintended consequences have throughout history often shown themselves to be more powerful than outcomes policy makers  were necessarily looking for. Milton Friedman and Anna Schwartz in their book "A Monetary History of the United States, 1867-1960" talk about the crime of 1873 when the price of silver was effectively pushed down relative to gold as setting the political climate all the way through the Presidential Election of 1900. Equally they suggest in "Money Mischief" that the US approach to Gold and Silver inadvertantly helped propel Mao and his long March to power over the top of Chiang Kai-shek.

We have already stated in the links section below we thing the Junk Bond rally a bubble of scary proportion and clearly an unintended new bubble consequnce of easy money.  So it is that the "Economist" Magazines Buttonwood column (cited in Interesting Links 20/9/2010 below) this week is running a story that the low interest rate environment globaly is  perhaps having some perverse impacts on behaviour. It says "Indeed, the rich world may be due for a cultural shift. If the motto of the past 25 years was “borrow now, pay later”, then “save now, rather than starve later” might soon be the more appropriate philosophy. Many people are unprepared for retirement. A staggering 47% of British women of working age do not have a pension plan, according to a survey by Baring Asset Management, and 22% of all adults aged between 55 and 64 are in the same position. If they think they will have a comfortable retirement on state benefits, they are in for a nasty surprise. Interest-rate cuts hurt savers’ incomes even as they make borrowers better off. If this income effect were to become powerful enough, it would be a nice irony. Low interest rates, which have the main aim of encouraging spending, could have the perverse effect of encouraging saving."

Once again it comes back to what is an increasingly astute analyis piece written by Andrew Haldane and referred to last week here. Patience forgone once shown to be illadviswed may indeed become simply patience delayed with consumers, investors and borrowers apt to seek to make up for lost time. we find it hard to understand how the so called advanced economies and their intellectual leaders missed the lesson of their poorer histories or of developing countries now. It is a lack of safety net that is often the reason for such a high level of savings in these developing economies. Once incomes rise to the level where government safety nets are provided and trusted consumption for every dollar of additional income can increase all other things equal.

The reverse must also be the case. Mustn't it? We believe that this is clearly analogous to the European debate about auterity. German policy makers or Northern Europeans more broadly, who we like to call austerians believe that austerity is good because by cutting services and deficits now pensions will be paid later so spending continues now. 

So as irrational as it may seem to "austerity your way to growth" we get the European idea. Kind of anyway. If consumers fret for their retirment incomes, savings and services the risk is that aggregate demand falls further. Either way when monetary policy loses traction the unintended consequence of trying to stimulate growth could be the reverse. To quote someone we read, apologies we can't remember who exactly but it could be Taleb, the longer this crisis goes on for the global economy then, quite possibly, we are further from the end not closer.

Interesting Links - 20/09/2010

Sovereign issues are raising their head again as the Irish are under pressure and now FT Alphaville suggests that Greek bank stress tests are to be delayed. Europe is a slow burn issue that has not gone away. http://www.ft.com/cms/s/0/1d650d1a-c410-11df-b827-00144feab49a.html?ftcamp=rss

On this Alphaville also has a guest post by "Mohamed El-Erian, chief executive and co-chief investment officer at PIMCO, argues that this week will show Europe’s debt crisis and the global configuration of currencies returning to the fore." We think it is going to be very difficult for policy makers to resist the siren song of the easy political rhetoric that this latest currency debate provides. Europe also continues to worry us greatly. http://ftalphaville.ft.com/blog/2010/09/19/346446/guest-post-el-erian-on-an-interesting-week-ahead/

On the currency wars Bloomberg picked up comments from BOK Governor over the weekend that Japan can not go it alone in defending the Yen's rise. We think there is little appetite for this at present so this is doomed to failure or more likely more bouts of the lone hand. http://www.bloomberg.com/news/2010-09-19/japan-can-t-curb-yen-s-gains-by-acting-alone-bank-of-korea-governor-says.html

Is the AUD over valued? According to Bloomberg, strategists and PPP it is. One thing we know for sure...if everyone says its going down its not. We are increasingly thinking that you can forget parity the AUD is going to head to 1.10 against the USD at some point. Perhaps not stright away but the Australian economy is a stand out, the RBA believes the China/India miracle has years to run. Next time risk goes off we'd expect the AUD to win but it should outperform against EUR, GBP et al. http://www.bloomberg.com/news/2010-09-19/gillard-dollar-is-peaking-as-mining-tax-proves-aussie-is-overvalued-by-27-.html 

We'll Blog this later today but unintended consequences of low rates, link the Junk Bond Bubble, can be very powerful. http://www.economist.com/node/17043652?story_id=17043652&fsrc=scn/tw/te/rss/pe

This is a joke. Low interest rates distort the performance of lower rated corporate credits because theree is an almost costless and unlimited ability to get finance. This means they tend not to default. Bubbles beget bubbles. here is the latest one. http://www.ft.com/cms/s/0/dd2f4000-c421-11df-b827-00144feab49a.html


In the US the tax cut debate is raging. Here is a link to who gets what from the NYT over the weekend via Barry Ritholtz's "Big Picture" Blog. http://www.ritholtz.com/blog/2010/09/who-gets-what-tax-cuts/

Currencies - Be careful at the Margin!

We love FX, it’s our favourite asset class. It is the only market that continued to function properly all the way through the crisis we had in 2007-09 and will likely be again as the globe is buffeted by oncoming headwinds. But it is a market not for the faint hearted or part timers.

We are really committed to helping people and investors better understand what is happening in markets and economics. That’s why we write this blog. Well, apart from the fact that we really enjoy the thought process and the writing.

  

It is with this in mind that we believe the Japanese intervention the other day proves once again the point made by Andrew Haldane (see blog below http://spotlight-onmarketsandeconomics.blogspot.com/2010/09/mr-markets-impatience-is-sending-wrong.html ) about the shortening of holding periods for assets.

Indeed the explosion in FX trade that is feed by margin brokers offering leverage of up to 100:1 is just another example of this short term approach and the self-reinforcement that short term holding periods beget short term trading strategies and short term traders. As many investors found in the stock market collapse in the GFC trading on leverage is a double edged sword. We’re sure that a few speculators and day traders got seriously burnt in USD/JPY’s run up to 85 from 83 in the space of a few minutes the other day. This Hourly chart from Bloomberg shows how sharp the move was.

  

While the Japanese intervention was the first in 5 or 6 years it wasn’t the only time we have seen these types of moves highlighting the risks in FX. The beauty of FX is that you can trade both sides of the market normally with equal ease of entry and exit 24 hours a day 5 and a half days a week. This is not the case in equities or bonds although it is probably the case with exchange traded futures, when they are open. But the key point that we would make is that trading FX is both fun and profitable but you have to be very careful at the margin and on how thin a margin you trade.

Interesting Links - 17/09/2010

Deflation is a real risk to the big North Atlantic economies even if Central Bankers are focussed on the opposite risks. This article from the Knowledge @ Wharton summarises the current situation well.
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2587

On Deflation the K@W article above cites a paper we read a couple of weeks ago by St Louis Fed President James Bullard titled "Seven Faces of 'The peril'" In the paper Bullard "discusses the possibility that the U.S. economy may become enmeshed in a Japanese-style deflationary outcome within the next several years." It's a wonkish paper but basically says that if the Fed signals it is going to keep rates low for an extended period it is counterproductive. Wonkish but worth the effort. http://research.stlouisfed.org/publications/review/10/09/Bullard.pdf

America is a conundrum to people outside. How can the wealthiest Country in the history of the Planet also have so much poverty. The newswires are all carrying a story from the Census bureau on poverty. This follows on from recent data on food stamp usage which is at a record. Here's a link to the ABC's version of the story. http://www.abc.net.au/news/stories/2010/09/17/3014196.htm

This is what happens when interest rates are zero and the cure for the disease is the same as the cause. FT Alphaville has an interesting article on the Junk Bond bubble. Our view is that if you can get money free then you don't default which distorts statistics in what is a very weak global economy. http://ftalphaville.ft.com/blog/2010/09/16/345311/junk-windfall/

More people offshore thinking there is a bubble in Australian Housing. At least here though Barry Ritholtz does try to make a point about differences in markets. He is our co-favourite blogger with Yves Smith. Both of whom are much more than that. http://www.ritholtz.com/blog/2010/09/realty-bubble-monitor-long-term-charts/

Currency Wars - is protectionism about to erupt?

Back in the 30’s Governments of all stripes around the world erected trade and tariff barriers in order to try to protect their domestic industry and economies from the worst of the Depression that was sweeping the world. Of course the unintended consequence of this was the opposite effect which lead to slowing trade and economic growth and as such was a self defeating shot in the foot which probably made the Depression worse than it should of, could of, would have been.

In this latest “Great Recession” governments have made it clear that they were not going to make the mistakes of their predecessors in aggressively pursuing self interested trade policies but this has not stopped them relying on currencies to do the job for them. Indeed if you were to ask what’s the difference between the UK , Greece and Spain the answer would come that while they each have economic, budgetary and debt problems at least the UK can let its currency go to stimulate exports.

Just look at the drop in Sterling (chart below) from around 2 when the GFC kicked off to around the 1.50/55 region that’s a rough 20/25% fall. Certainly the Euro has also dropped by a little under 20% but arguably Greece and Spain need moves of double this at least to help get out of their mess. But Germany on the other hand is more than happy with the performance of the Euro and the impact on its exports recently and in the face of the weak growth profile of its near neighbours. The Japanese on the other hand have had the opposite problem with Dollar Yen moving from 110 to around 83 before this week’s intervention. That is a whopping appreciation of 25% with the associated loss of competitiveness that goes with it.

Source: Bloomberg, Spotlight 

So it’s no surprise that the Japanese intervened yesterday. But this, along with the Chinese intransigence and unwillingness to let the Renmimbi find its true value, may presage a coming currency war where each Government is seeking to competitively devalue its currency in order to stimulate trade related growth.

Earlier today we posted a link to a page on Bloomberg that considered the Japanese intervention yesterday that pushed Dollar Yen and Euro Yen sharply higher. Today we see stories in the Press that there will be further intervention and renewed and refreshed Japanese Prime Minister Naoto Kan said that “We’ll continue to take decisive measures when necessary...If rapid Yen movements hurt the desire of Japanese companies to invest at home, employment conditions will get worse.”

Now we understand the Japanese desire to keep its currency as weak as possible particularly after a decade of economic stagnation and in truth against an appreciation that seems un warranted given relative economic outcomes but is this just the thin end of the wedge? In the run up to the November mid-term elections the United States is becoming less tolerant of the Chinese stance on its currency and as the rhetoric grows so do the risks to the global economy.

Today’s edition of the New York Times is running a story on this very topic and says “The Obama administration is moving to take a harder stance on the Chinese government’s trade and currency policies, with anger toward China rising in both political parties ahead of midterm elections.” Indeed we know, because Treasury released statements overnight that US Treasury Secretary Tim Geithner is going to say before House and Senate panels tonight   that ““We are concerned, as are many of China’s trading partners, that the pace of appreciation has been too slow and the extent of appreciation too limited,”

The US Treasury danced around the subject of currency manipulation by the Chinese already in the last few months but it is clear that the aggravation level  is growing in Washington. The New York Times says “The United States brought two cases to the World Trade Organization on Wednesday, accusing China of improperly blocking imports of a specialty steel product and denying credit card companies access to its markets. The move came just hours before House lawmakers demanded action on the currency issue.” It further goes on to say that “Senator Charles E. Grassley of Iowa, said, “It’s about time the administration decided to act. Mr. Grassley added: “The administration should go one step further and bring a case against China’s unfair currency manipulation at the W.T.O.”

With the Tea Party getting up its candidate on the Republican Ticket for the Delaware Senate race it may be the case that the energy being shown in conservative ranks cause the GOP to lurch further to the right and take the Administration and Democrats with them  in the run up to the mid-terms.

The Japanese intervention yesterday and the increasing noises from Legislators in the US suggests a dangerous flouting with policies that will not help engender global growth. None of this is good for the global economy at the point when the chances of a double dip in the US are getting dangerously close to 50:50 and where Europe and Japan remain essentially stagnant.  What the world needs is a focus on growth and jobs not currency manipulation and competitive devaluations. Governments need to deal with their own internal lack of aggregate demand first rather than try to poach demand via competitive devaluations and artifically low currencies.

Interesting Links - 16/09/2010

The GFC is all about a lack of aggregate demand Paul Krugman has a ggod link on his blog http://krugman.blogs.nytimes.com/2010/09/15/its-demand-stupid/

Michael Lewis is one of our favourite writers. Whether it was "Liars Poker" and the old trading room at Salomon's , through the Oakland A's in "Moneyball" or his recent book about the GFC "The Big Short" he is always entertaining and insightful. Here is a link we read the other day to a Vanity Fair article on Greece. Another Good read http://www.vanityfair.com/business/features/2010/10/greeks-bearing-bonds-201010?printable=true

Our co-favourite Blogger Barry Ritholtz has a link for the Lehmans 2 year anniversary. http://www.ritholtz.com/blog/2010/09/lehmans-bankruptcy-2-year-anniversary/

The Japanese intervened in the USD/JPY market to support the Dollar yesterday and weaken the Yen for the first time in 6 years. This is no small move on their part and it drove the USD/JPY up 2.5 big figues and the EUR/JPY the best part of 4 big figures. We are worried that this is the start of beggar thy neighbour FX policies which would not be a good thing for the global economy. Here is a story from Bloomberg.
http://www.bloomberg.com/news/2010-09-15/japan-s-solo-run-on-yen-may-reveal-flaw-in-global-drive-on-export-recovery.html

Mr Market's impatience is sending the wrong signals.

FT Alphaville tipped us off to a speech given by the Bank of England's Andrew Haldane earlier this month where  he discusses "Patience and Finance". We'll write a bigger blog in a day or so to discuss this magnificent paper and its implications for markets and investors. But one of the key things we want readers to understand is that the trend to short termism of which the so-called "flash" traders are the most obvious recent iteration is an evolutionary manifestation of an intellectual version of Gresham's law. That is impatience is chasing out patience as the holding period for investors and traders is shortened to such an extent that it becomes difficult, nay impossible, to hold a medium term view.

Haldane says "In 1940, the mean duration of US equity holdings by investors was around 7 years. For the next 35 years up until the mid-1970s, this average holding period was little changed. But in the subsequent 35 years average holding periods have fallen secularly. By the time of the stock market crash in 1987, the average duration of US equity holdings had fallen to under 2 years. By the turn of the century, it had fallen below one year. By 2007, it was around 7 months. Impatience is mounting."

And this is before flash traders and their super computers who knows how short the average holding period is now?

Short termism and impatience is no good for anyone, evolution has shown us that. We'll talk more about this paper later but for the moment it tells us that nothing substantial or concrete can be garnered from day to day or even week to week moves in markets. They'll just be following the data, thin slicing and finding a way to make a quick buck. Indeed given the fundamentals in Europe and the United states we'd say that equity markets are currently sending the wrong signals. Time will tell.

Link to the speech: http://www.bankofengland.co.uk/publications/speeches/2010/speech445.pdf

Interesting Links 15/09/2010

This is just a snapshot of what I think is interesting at the moment.

http://www.ft.com/cms/s/0/580109dc-bf43-11df-a789-00144feab49a.html FT on European Banks addicition to ECB Loans (may need a subscription)

http://www.voxeu.org/index.php?q=node/5506 EU banks and sovereign debt exposures in Voxeu.com Markets are desperately trying to ignore the problems in Europe and its banking system. Unfortuantely we can't.

http://www.theaustralian.com.au/business/news/bernankes-job-not-getting-any-easier/story-e6frg90x-1225923512583 WSJ via the Australian - just how weak does the US economy have to get before more money gets thrown at it? perhaps we have to wait till after the November elections to get a "clearer" picture

 I'll update more during the day as I come across interesting things

Housing - Bubble a Myth?

Following on from yesterday's post we thought we'd highlight a leter to the Editor of the AFR by Housing Industry Association Chief Economist Harley Dale yesterday that we missed. Now Harley is clearly an advocate for his industry but, having had close contact with him in our past, we can vouch for his credibility and deep understanding for all things housing.

Writing to the AFR he said "Australia continues to grapple with the incessant hyping up of a fictious housing bubble...the reserve Bank of Australia does not subscribe to the bubble view nor does Treasury....Australian house prices have been driven by strong demand and low supply." We agree and indeed if we were to look at the population to housing equation more deeply we would see the strength in this argument. But as followers of Minsky we do have some sympathy with the overall view that house prices may have skipped ahead a little as we noted yesterday.

But the key point to our mind for those who are incessantly talking about bubbles and particulalry those from offshore who want to be among those prescient soothsayers who called the future crash in Australian house prices is, as Harley notes, "Those claiming that Australia's housing market could go the same way as the united States have no understanding of reality. Australia's market is vastly different to the US." Certainly the bears will say that "bubble deniers alway say that" and they are, up to a point correct.

But to our mind there are many differences between Australia and the US. Leaving aside 5.1% employment, a surfiet of housing demand and a strong banking system the most important point  for us is full recourse lending. We flippantly suggested yesterday that this full recourse lending may not protect the banking system longer term as stigmas change  but this would only be at the margin. Rather we think the role institutions play is completely misunderstood and under appreciated in the analysis of the Australian Housing Market particulalry with respect to talk of a bubble and its inevitable implication that people will become distrssed sellers thus driving prices down sharply.

To this end a paper published by Burcu Duygan-Bump of the Federal Reserve Bank of Boston and Charles Grant of the University of Reading (Household Debt Repayment Behaviour: What Role do Institutions Play?, Economic Policy. Vol. 24. No 57. pp 107-140. January 2009) is worthy of note. The research into default behaviour is scant and this was done in reference to Europe but it has implications for Australia and full recourse loans.

The authors found  "arrears are frequently associated with subsequent adverse consequences, such as future unemployment or bad health. Second, we find that arrears are often precipitated by an adverse shock to the household's income or health, but that there are large differences between countries in how households react to these events. Finally, we show that these differences can be partly explained by local financial and judicial institutions, as captured by contract enforcement and information sharing indicators. In other words, we show that while adverse shocks are highly important, the extent to which they affect repayment behaviour depends crucially on the penalty for defaulting." Spotlight's emphasis.

So full recourse loans and both the willingness of the lender to enforce their rights and the strength of the judiciary in achieving same make a big difference in the level of defaults. This brings us back to the conditional probability idea we talked about yesterday. What is going to cause the causes that cause the cause of the default? The paper gives us some clear pointers as well and we note that there is a certain reverse causality between mortgage stress and job losses. So to this end the Australian Governments initiative with Australian ADI's to implement a protocol of working with customers in difficulty looks to be a pretty solid circuit breaker as well on the road to default.

We been around and studied markets long enough to never say never but Harley Dale is right, the focus should be on providing more affordable housing not trying to prick a supposed bubble one that may not even exist.

 

Australian Housing - some dangerous trends re-emerge

Some articles in the press over the weekend are worrying in the sense that we have now seen the re-emergence of a 105% home loan to help new entrants into the market. Equally the article cited the increasing of acceptable LVR's at the majors suggests that with Housing Finance off so sharply from its recent high mortgage lenders are doing whatever they can to stimulate demand at a time when clearly Australians are rightly being more circumspect.

In another piece which is analogouos to the above the headline asserted that "Banks are 'lending into a housing bubble' research firm warns"

There is a lot of atmospherics globally at the moment about Australian house prices and the “fact” that they are a bubble. We have a lot of sympathy with the view but it is hard to see the catalyst for the nominal bust we are increasingly hearing about. Many argue that this "bubble" must bust because "all bubbles do" but with little else supporting these assertions other than some thinly sliced analysis. Gerard Minack of Morgan Stanley is not one of these thin slicers and in his recent paper basically said, among other things, that it can only be a big uptick in unemployment or investors forming the view that that housing investment is a dud investment after costs once capital appreciation slows or stops.


We agree with Minack on both counts but we then have a conditional probability issue. That is, what causes the causes that cause either the reappraisal in investors or the uptick in unemployment??? For unemployment in the current economic circumstance we would need  China to fall over while the rest of the world is still struggling but what are the chances of that? Possible, Yes, probable, not at the moment. As for investors that would require a cultural shift which is inherently unforecastable.

Certainly we know over the long term that there is a strong relationship between demand for housing finance and house prices (see chart). Housing finance is off sharply again and a straight line relationship would suggest prices to fall (nominal) in coming quarters. But history tells us prices fell in "real", inflation adjusted terms not nominal last time this happened in 2003. So what the banks are doing may well increase demand for housing by making it more accessible to new entrants and giving uptraders the ability to stretch a little further, thus supporting prices for the moment.

Source: ABS, RBA, Bloomberg and Spotlight

We continue to favour a small nominal fall over the next five+ years but a decent inflation adjusted fall. But if we really are going to pour fuel on the fire then we could be off by a long margin or we simply forestall the inevitable.

No doubt what the banks are doing is, at face value, dangerous however we bet they are banking on the historic precedent of low defaults based on the stigma of bankruptcy and the structure of the debt such that you remain personally liable as a safety net to their lending in Australia. If house prices fall banks don’t actually lose until they have to foreclose and then only if they can’t recoup outstandings and by the way anything above 80% is, in general, the mortgage insurers problem. It’s another of those conditional probability arguments that makes the loss given default so small as to make it remote from the retail bankers individual lending decision. However dangerous this may be for the macro economy.

History tells us that is a reasonable assumption but we wouldn’t bet gen y or the late gen x’s will care as much as their parents on what their credit score is or the stigma of bankruptchy. They are just as likely to blame the banks...its ok then!