The Experts

David Bassanese
+ About David Bassanese

David Bassanese is one of Australia’s leading economic and financial market analysts, who has authored several investment books and works in a number of advisory roles.

David is Chief Economist at BetaShares, which involves providing economic and investment portfolio advice to both retail and institutional investors. David is also an economic advisor to the National Institute for Economic and Industry Research.

Prior to these roles, David was Economics Commentator with The Australian Financial Review, where is regular “Bassanese” column appeared three times per week, as well as monthly in Smart Investor Magazine.

David’s analysis and commentaries cover local and international economic trends, interest rates, the exchange rate, and share market analysis.

Prior to becoming a Fairfax business columnist in 2003, David spent several years in financial markets as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank. David started his career at the Federal Treasury in Canberra, after which he spent several years as a research economist at the Organisation for Economic Cooperation and Development in Paris, France.

David has authored two e-books: The Australian ETF Guide: cheap and easy investment strategies using exchange traded funds (ETFs), and The Australian Investor’s Guide to Asset Allocation.

David has a first class honours degree in Economics from the University of Adelaide, and a Master in Public Policy from the J.F Kennedy School of Government at Harvard University.

Households and business in tug-of-war over economy

Wednesday, October 11, 2017

By David Bassanese

The Australian economy is engaged in a tug-of-war between households and business. Households are in a funk, while business remains resolutely upbeat.

Euphemistically, it’s what economists call a “mixed” economic outlook.

Another popular phrase is that the data are “conflicting”.

In turn, that’s left a few of the nation’s financial market economists thinking the next move in interest rates will be up, whereas others (including myself) can’t see the Reserve Bank moving one way or another for at least another year. There’s still even a chance the RBA could eventually cut rates again.

Just witness what we’ve seen in the space of a few short days.

Last week we got a retail sales “shocker”, which revealed spending at our malls and shopping strips dropped 0.6% in August after a (downwardly revised) 0.2% decline in July. Of course current September quarter weakness follows a spike in sales in the June quarter, which now appears to have reflected post-flood re-stocking in Queensland. Overall, retail spending can best be described as choppy around a fairly weak underlying trend.

Soft retail spending is certainly consistent with other trends in the economy – such as weak wages growth, high household debt, and the recent squeeze in real incomes caused by a further spike in electricity prices.

It’s also consistent with the weakness in the retail sector seen in National Australia Bank’s monthly business survey.

But here’s where the differences emerge. The NAB survey released yesterday showed overall business conditions in September remained at robust above-average levels. According to corporate Australia, overall trading conditions are doing nicely, and businesses still intend hiring many more workers in the months ahead and are slowly but surely lifting non-mining capital spending plans also.

In turn, corporate optimism is consistent with what can only be described as boom conditions in the labour market. Net new jobs surged by 54,000 in August, and by 2.7% over the year – even though the unemployment rate still remains stuck around the mid-5% level.

So even though consumer spending and household sentiment is at best patchy, corporate Australia is pretty happy and still keen to take on workers.

Why is this so? And will downtrodden consumers drag business down or upbeat corporations drag hapless households up?

Looking through a range of other indicators, including the NAB survey, several positive business trends are apparent.

For starters, we are still enjoying a strong housing construction boom, together with a public infrastructure boom, both of which are also having nice downstream effects on the manufacturing sector. Strong Sydney and Melbourne property sales are also keeping real estate agents and lawyers very happy. The LNG gas and coal/iron-ore export shipping booms are also continuing, which is still holding up jobs and keeping the transport sector happy (though gas exports are arguably contributing to high electricity prices at home). In services, our increasingly revenue hungry universities are taking on more students in droves, even if the quality and cost of education is consequently suffering. For demographic reasons, the health care sector continues to boom also – as is spending on mobile phones and broadband services.

In short, there are a lot of positive drivers in the economy – which is being reflected in overall still positive levels of business conditions and employment. That said, many important traditional industries from retailing to media are facing the blowtorch of competition. More generally, average workers are still struggling to get a decent wage increase, and still feel their employment situation is vulnerable. Consumer spending (particularly traditional “bricks and mortar” retail spending) is understandably therefore dragging the chain.

The good news is that many of these positive forces – like infrastructure, exports, education and health - are likely to continue well into next year. However, the housing construction boom does appear close to a peak and will head into reverse in 2018. And households in Sydney and Melbourne will be feeling even less upbeat once signs of flatter house prices emerge. Traditional retail and media companies also face ongoing structural challenges – especially from upstart dotcom darlings that don’t hire many and shovel most of their profits offshore.

My overall sense is that this means the tug-of-war taking place across the economy will continue – a case of two steps forward and two steps back. In turn, this will frustrate the RBA’s hopes of 3% growth emerging in 2018 and will likely mean interest rates won’t budge either way for some time to come.


America’s economic expansion could just keep going

Wednesday, September 27, 2017


Don't lose faith in global equity markets

Monday, September 18, 2017

By David Bassanese

Having spent the past week travelling the country on an ASX Investors Road Show, I thought I’d share with you a few of the key takeaways from my presentation.
The bottom line is that I remain cautiously bullish on the global economic outlook, and hence global equity markets. Globally, we are enjoying both an increasingly broad-based or “synchronised” upturn, with Europe, Japan and several emerging markets picking up over the past year to join the longer established US economic recovery. Fears political populism and an EU-breakup are receding in Europe, and even the long-touted Trump fiscal stimulus has so far not been needed.  
What’s more, it’s what might be termed a “Goldilocks” global economy, with growth neither too hot to cause undue inflation and higher interest rates, but also not too cold to push up unemployment and crush corporate earnings. Importantly, with inflation still generally low across the world, central banks generally remain very reluctant to withdraw their punch bowls quickly.
Low inflation and accommodative central banks mean that global bond yields remain very low. Indeed, the Bloomberg Global Aggregate Bond Index retains a yield-to-maturity of only around 1.5%.
Against this backdrop, while global equity price-to-earnings (PE) valuations are modestly above average, this seems easily justified for now given the rich valuations in the bond market. What’s more, global equity markets are also being underpinned by good gains in corporate earnings – helped by improvements in sales activity (consumer spending and business investment) and very tight control of costs. Both European and Japanese corporations are also showing a determination to match US rivals in terms of return on equity.  
So far so good. The bad news for Australian investors, however, is that patchy earning performance continues to hold back the local market. While resource companies have produced decent earnings growth of late, thanks to a rebound in iron-ore prices (the sustainability of which is doubtful), we especially lack the tech darlings that are lighting up global markets. From a market or industry sector perspective, Australia remains a good place to source income opportunities, but it’s a case of “go global for growth”. Thankfully, seeking out global growth sectors (like technology, health care or agribusiness) has never been easier for Australian investors thanks to the advent of exchange traded funds (ETFs) which can be bought and sold on the ASX just as easily as a company share.
Of course, there are risks. The US labour market is tightening, and a pick-up in wages and/or price inflation might still be just around the corner. If so, the Fed will tighten policy more aggressively, which could spell the end of the current 8-year global bull market. That said, price and wage pressure remains quite low in the US, and there are strong structural reason why this might remain the case.
Another obvious risk factor is North Korea. But get this: it may surprise some investors to know that the South Korean Benchmark equity index, the KOSPI 200, is up 20% so far this year. Since the current troubles with North Korea started a few months ago, the Korean market has pulled back by only 2.5%.
If even the South Koreans - who would be ground zero in the event of a war - aren’t worrying about North Korea too much, it suggests we might take a measure of comfort also. I guess baring widespread nuclear annihilation (which is not worth insuring against anyway!), the North Korean stand-off seems more likely to end in either a diplomatic solution or regime change though a relatively quick and decisive US assault.


ABC's Four Corners misses the real story on dodgy lending practices

Wednesday, August 30, 2017

By David Bassanese

Don’t get me wrong: I think the ABC public broadcaster is one of Australia’s most treasured public institutions. And the long-running Four Corners program often does a tremendous public service in regularly exposing cases of public or private business misbehaviour.

That said, the premise of a recently aired Four Corners program - that Australian house prices and household debt are dangerously high and this has been largely caused by dodgy home lending – is simply wrong.

Worse, the story glided past a real public policy issue that it could have explored in more detail.

Of course, the Four Corners premise is a great story angle as it fits so neatly with what happened in the United States – and parts of Europe – more than a decade ago and led eventually to the global financial crisis. And sure enough, it’s always possible to find a few hard luck stories or cases of extreme greed and ignorance.

But it’s a big stretch to claim poor lending has driven up Australian house prices alone, and that the economy and banks are dangerously over extended.

Not mentioned in the program were the role of super low interest rates, strong immigration, restricted Sydney supply due to inner-city development constraints and poor transport links to more affordable regional areas, and the boom-bust mining cycle that did lead to regionally specific housing bubbles in certain parts of Western Australia and Queensland.

Unlike in the United States, Ireland and Spain moreover, Australia overall has not been swamped by housing supply in response to high prices in a way that would force prices down. Unlike in the US, moreover, our mortgage lending is recourse – meaning banks can come after any other assets you might own if you default on your mortgage. Indeed, even in Perth where property prices and employment have slumped in recent years, default rates are hardly catastrophic.

The great pity of the Four Corners program is that it tried to portray dodgy lending practises as the cause of a nationwide housing bubble - i.e. a macro-economic problem – and missed the real story that it’s nonetheless still a serious micro-economic problem that hurts the most financially vulnerable and gullible in our community.

Indeed, in one of the major cases in the Four Corners report, one lady nearing retirement claimed she was goaded into buying an investment property by a telephone sales pitch. She also claimed she provided no information regarding her income on the broker-completed mortgage application which was eventually accepted by the ANZ Bank.

It begs the question: was the loan document falsified or not, and does the ANZ – and other banks for that matter - simply take such provided information on faith or do its own checking? On camera, ANZ CEO Shayne Elliott claimed the bank does a “thorough due diligence on [borrowers] ability to repay their loan.” How thorough – are the income statements verified with the borrower or not?

Following the glare of Four Corners publicity, the ANZ Bank appears to have reached a compromise settlement with the lady in question. Four Corners in turn noted on air that “the Bank conceded [she] was targeted by aggressive sales tactics by the broker and developer.” We were then invited to read ANZ’s full statement on the Four Corners website.

But although curiously not mentioned on air, this statement included the startling fact that ANZ “had written to her advising she was overpaying for her investment”. That’s nice of the bank, but it still went ahead and lent her the money!

ANZ also claimed she “also acknowledged that she was responsible for declaring her estimated expenses and advising ANZ her financial position was not likely to change in the near future.” I could be wrong, but this suggests the ANZ does not independently verify the financial data on applications submitted by brokers. ANZ also had to explain to her that it was not their job to “provide her advice on her investment plans.”

This is the real story that Four Corners glided past. Even though the conflicts associated with financial product commissions have been largely eliminated, compliance burdens continue to make sorely needed financial planning services so expensive in Australia that only 25% of households seek it out – the rest are left to fend for themselves and often end up victims in the less regulated property sector.

The bad news is that this can lead to immense grief for the overly greedy or gullible. The good news at least, and contrary to what Four Corners claim, these investors still seem rare enough that they have not placed the whole economy – or more specifically the banking sector – in peril.


Fear not over-indebted households - there's safety in numbers

Wednesday, August 16, 2017

By David Bassanese

Fear not over-indebted Australian households – having debt has its problems, but also its advantages.  

Rightly or wrongly, Australian households are finding this out right now given the Reserve Bank’s caution about lifting interest rates anytime soon.  

There’s safety in numbers - big numbers. 

Indeed, it was John Paul Getty who once quipped that if you owe the bank a $100 that’s your problem, but if you owe the bank $100 million then it’s the bank’s problem. 

Famed Australian entrepreneur Alan Bond lived by the same motto, figuring he had great bargaining power over the banks given he tended to owe them a lot of money. And even the great Wall Street banks such as Goldman Sachs and JP Morgan were granted protection during the global financial crisis, because the sheer size of their operations and debt levels meant they were simply too big to fail.

In this sense, the Australian household sector is also too big to fail – and the RBA knows it. 

Indeed, consumer spending accounts for around 50 to 60% of economic growth and so were households to suddenly decide to close their wallets and focus on paying down debt it would send the economy into a spin, and make paying down those debts all the harder.

Thanks to low interest rates and the current housing boom across the east coast of Australia, the ratio of household-debt-to-disposable income has ratcheted up since 2012 from around 170% to 190%. By global standards, this ratio is relatively high – at least compared to larger economies such as the United States, Germany and Japan. But it’s not too far out of line with debt levels in Canada, New Zealand and several Scandinavian countries.  

Either way, the debt load - along with weak growth in wages and perceived employment vulnerability - has left consumers with new found caution. Consumer confidence remains decidedly less upbeat than business confidence and overall household spending in the past year or so has been patchy. 

The good news for indebted households – though not for those reliant on interest income – is that their debt vulnerability has not gone unnoticed at the RBA. 

In the minutes to its July policy meeting released this week, for example, the RBA Board noted that “the high level of debt on household balance sheets raised the possibility that consumption growth could be lower than forecast”. What’s more, it was also noted that “the need to balance the risks associated with high household debt in a low-inflation environment” was also influencing the Bank’s decision to leave interest rates on hold – even though a range of economic indicators had improved of late.

It’s been this vulnerability that has also encouraged the RBA – along with the Australian Prudential Regulation Authority (APRA) - to introduce a new range of so-called “macro-prudential” controls to better target the problem areas of speculative property borrowing without hurting everyone with a mortgage. The net effect has been that interest rates faced by property investors, and especially the vast bulk of those with interest-only loans, have increased by around 40 basis points so far this year – almost two full RBA rate rises. Meanwhile, the mortgage rate for existing owner occupiers with traditional principal and interest loans have hardly changed. 

Although the housing markets in both Sydney and Melbourne remain hotter than officials ideally desire, it’s fair to say the introduction of better targeted policy measures has been a welcome innovation and has left policy-makers with far greater flexibility to manage both inflation and financial stability.

Accordingly, until such time as inflation rises more strongly and/or the economy gets a greater head of steam, don’t expect the RBA to use the blunt instrument of official interest rates changes to tackle lingering strength in our hot Sydney and Melbourne property markets. If push comes to shove, it seems more likely that APRA will impose even tough restrictions on investor lending, possibly even quarantined to activity in our hottest cities.   

As I said earlier, many households have high levels of debt – but there’s safety in numbers. 


Should we consider more drastic measures for a lower dollar?

Wednesday, August 02, 2017

By David Bassanese

The bad news for the Australian economy and local corporate earnings is that the Australian dollar remains strong - even though the Reserve Bank has done what it can to douse speculation that it was contemplating a hike in interest rates sometime soon.

That may mean we might need to eventually consider more drastic measures to keep the $A competitive – such as some form of tax on hot money flows into the country. After all, we have already party re-regulated the financial sector through new “macro-prudential” controls, which have given policy makers extra flexibility to manage the housing sector without resorting to across-the-board interest rates changes. Some new tools might also be needed to deal with the $A.

As I predicted in my last Switzer Daily column, both Deputy RBA Governor Guy Debelle and Governor Phil Lowe went out of their way in recent weeks to explain that recent references to the “neutral” RBA cash rate now being around 3.5% were not meant to indicate the RBA thought rates remained too low (at 1.5%) and needed to be lifted quickly.  

Near-term rate hike expectations have eased accordingly. Yet, the Australian dollar remains stubbornly close to US80c. As the RBA noted in its post-meeting statement this week, however, a large factor behind the $A’s apparent strength is broad-based weakness in the US dollar. Since the start of the year, for example, the $A is up around 10% against the US dollar, but it’s down slightly against the Euro and up only 5% against the Japanese yen.

The US dollar globally remains unloved – due to both diminished hopes of US fiscal stimulus from the increasingly dysfunctional Trump Presidency, but also because expectations of monetary tightening in other economies (notably Europe, but not Japan) have lifted relative to those in the United States.

All this leaves the RBA in a desperate bind. It can’t cut interest rates to help lower the $A as this would only add fuel to the speculative fire still heating up Sydney and Melbourne house prices. And it is now even less likely to consider a “shot across the bows” lift in rates to prick the bubble in speculative sentiment in these hot markets, lest this send the $A catapulting even higher and crush business confidence in the process. 

Policy makers are tackling these twin problems through other instruments. Macro-prudential controls – such as demanding banks cut back on home lending – are trying to dampen hot house prices, and APRA may need to do more in the weeks ahead if there’s not greater evidence of a cooling in the property mania.

As for the $A, the only other instrument available at this stage is RBA “jawboning.” In its policy statement this week, the RBA did acknowledge that a higher Australian dollar posed downside risks to the economy, but the jawboning was not particularly strong, which does seem a little surprising and disappointing.

That said, I also sense the RBA is cautious about trying to jawbone too much, as it fears this might have only a temporary effect, if any at all. Failed jawboning might expose that the Emperor has few clothes. 

Complicating matters further, to a degree a somewhat firmer $A also seems justified, given the continued strength in iron ore prices – which in part, seems fundamentally based given the ongoing strength in Chinese steel production, but also part speculative as iron ore futures have become a plaything for Chinese retail investors.  However, the relative contribution of fundamentals and speculation to short-term moves in the iron ore price is difficult to untangle, which also makes it unclear how much of the $A’s broad strength seems justified and is likely to last.

What to do? We can hope that the US dollar begins to strengthen again – and that is certainly possible if US inflation does rebound and the Fed reaffirms its tightening bias. Who knows, even Donald Trump might finally focus on tax cuts and infrastructure spending and succeed in getting a fiscal stimulus package through the Congress (but I won’t hold my breath). Iron ore prices might also fall back if China eases back on stimulus and/or speculative fervour wanes.

But a growing risk is that the $A could remain uncomfortably high for a while – especially if the Fed goes soft on raising US rates.  

How concerned the RBA becomes will ultimately depend what effect this begins to have on the economy – in particular, whether it leads to a collapse in the currently high levels of business sentiment. 

If all this comes to pass, it’ll mean Australia is once again on the losing end of the global currency wars. If a hot housing market stops us from cutting rates to deal with the strong $A, that may mean other instruments might need to be considered.  

It’s a possibly radical thought – but so was re-imposition of bank lending restrictions only a few years ago.   


Is the soaring Aussie dollar just an overreaction to recent events?

Wednesday, July 19, 2017

By David Bassanese

The Australian dollar is a sell at current levels, and currency-unhedged global stocks are now even more enticing for local investors. 

A few factors have conspired over the past week to push the Australian dollar to the top end of its multi-year range. Indeed, the $A now looks tantalisingly close to touching US80c, and economists – as usual in times of market excitement - are outbidding each other to predict just how far can it go. 

But to my mind, the $A’s move seems an overreaction to recent events and traders are also underplaying how dismayed the Reserve Bank is likely to be over its recent strength – making it even less likely it will hike local interest rates anytime soon. 

The first overreaction seems to have been to recent commentary from the US Federal Reserve chair, Janet Yellen. In her testimony last week, she suggested that America’s so called “neutral” interest rate is “currently quite low by historical standards” and so “the federal funds rate would not have to rise all that much further to get to a neutral stance”. The neutral rate is usually defined as that which would neither overly stimulate, or hurt the economy.  

That said, Yellen also indicated that she expected the neutral rate to rise in coming years as the economy improved, meaning “additional gradual rate hikes are likely to be appropriate over the next few years.” In other words, the neutral rate – at least on this definition - is not fixed in stone and can move in line with developments in the economy. Indeed, the Fed’s medium-term fed funds projections still has it settling at around 3% over the next few years, compared with only around 1 to 1.25% today.

Frankly, Yellen’s decision to discuss the neutral rate in this way was clumsy and seems to have more confused than informed the market. 

What also excited the market, however, was Yellen’s acknowledgement that inflation has surprised on the downside in recent months, and hint that if this persisted – which she does not expect - it could affect the Fed’s desire to lift interest rates going forward. 

This is a potentially more serious threat to the outlook for higher US interest rates – as there is indeed a good chance, I think, that US inflation will hold stubbornly below the Fed’s preferred 2% target. History alone suggests as much. 

But the risk for the Fed, in this case, will be a potentially explosive further upward move in equity prices and decline in bond yields – which would create the risk of creating destabilising financial bubbles down the track. I think provided the economy keeps churning out good employment growth – as I expect - the Fed will still be of a view to continue tightening gradually, even if US consumer price inflation hovers somewhere between 1.5% and 2%. 

That means a rate hike in December still seems more likely than not, and moves to start running down the Fed’s huge accumulated bond holdings by September.

Meanwhile, adding to the local confusion were the minutes from the Reserve Bank’s June policy meeting released yesterday. In the minutes, the RBA felt the need to discuss our own neutral interest rate, and suggested it was now somewhat lower than before the financial crisis – around 3% rather than 5%. One interpretation of this statement would have been – as alluded to in America by Yellen – is that interest rates don’t need to rise as much to get to neutral. But the local market took instead took this as a hint that the RBA was keen to raise rates as they were still well below neutral. Again, I think this an overreaction. 

What’s more, I’d note that the RBA’s June policy meeting – to which the minutes referred – came before Yellen’s dovish speech last week and the strong bounce in the $A. I think the RBA would be even more reticent to hint at higher local interest rates now, and I suspect it might reveal a more dovish tone in important speeches by Deputy Governor Debelle on Friday and Governor Lowe next week.

All that said, if the Fed does decide to go on hold due to persistently low inflation, it’s very hard to see the RBA hiking rates anytime soon – and it could still cut rates – given the obvious upward pressures on the $A otherwise.

All that points in the direction of the $A holding its recent range, even if the Fed turns a lot more dovish. The same can’t be said for equities or bond yields, however, which would both shoot up and down respectively.   


Don’t expect RBA to join policy tightening bandwagon

Wednesday, July 05, 2017

The Reserve Bank of Australia this week pointedly refused to join the chorus of other central banks who have decided over the past week or so to flag the possibility of policy tightening later this year. The RBA’s refusal to join the hawkish bandwagon was a surprise to many market traders – so much so that the $A dropped and bond yields fell following the RBA’s post-meeting policy statement.

Yet the RBA’s reluctance to follow the new global trend should be no surprise. After all, the shift in global growth dynamism in recent years – from China’s smoke stack industries to America’s Silicon Valley - is not overly conducive to Australia’s growth prospects. Iron-ore prices have seen their best days, and the growth of America’s tech giants is more a threat than saviour of Australia’s ailing media and retail stocks – not to mention their landlords in the listed property sector.

Australian economic growth and corporate earnings are likely to underperform global peers for some time. Accordingly, the RBA should and likely will lag the moves of other central banks – not only in the United States but also the United Kingdom, Canada and even Europe – to withdraw the emergency levels of policy stimulus that have more or less been in place in their economies since the financial crisis almost a decade ago. 

The great hope of the RBA is that the gradual re-normalisation of monetary policy settings in other parts of the world will help (finally) drag down the $A to more competitive levels. As I’ve long argued, with the mining boom over and the housing construction boom reaching a peak, only a notably weaker $A – barring major new fiscal stimulus from either the Federal or State Governments – will provide the next leg of growth impetus that the economy will desperately need over the next year or two. 

Indeed, the RBA suddenly appears a little less bullish on the economic outlook than it seemed only a month ago. In the past two post-meeting policy statements, the RBA clung to its confident prediction that economic growth would accelerate to “a little above 3%” over the next couple of years.  That confidence went missing in action in this week’s statement following the July policy meeting. The only comment the RBA could muster was that the economy “is expected to strengthen gradually”. 

What’s changed? I suspect the RBA is becoming a little less confident that wages growth is likely to pick up anytime soon – despite recent declines in the unemployment rate and reasonable job gains. Indeed, the international evidence increasingly suggests that wage growth is failing to accelerate in either the United States, Europe or Japan despite apparent growing labour market tightness. Concern over wages is apparent from the fact RBA Governor Phil Lowe, in a recent speech, amazingly seemed to cajole workers into exercising their apparent enhanced bargaining power and demand more from their employers.

Of course, the RBA’s concern is not with wage growth per se, but rather the risks that continued weak household incomes pose to consumer spending – which still accounts for just over half of all economic growth in the country. The weakness in consumer spending over the past two quarters has likely already undermined the RBA’s bullish growth expectations for this year, though there has been a feisty rebound in monthly retail sales (which are notoriously volatile) over the past couple of months. 

What’s more, the longer wages growth stay low, the more likely that inflation expectations will ratchet down (from around 2 to 2.5% to something less), which in turn will make it all the more harder for the RBA to achieve its 2 to 3% inflation target over the medium term.

All up, don’t expect the RBA to join the bandwagon of other central bank’s that are now trying to prepare their own financial markets for an eventual tightening in policy over the next six months or so. Although our official interest rates are at below-average levels, they remain ridiculously low in many other parts of the world – especially in Europe and Japan. What’s more, many other centrals banks took it upon themselves to buy up billions in their own government’s debt so as to force down bond yields also. 

Policy re-normalisation is much more pressing in these countries now that economic growth has improved and deflation fears have passed almost a decade on from the financial crisis. 


Is Moody's bank downgrade cause for shock and alarm?

Wednesday, June 21, 2017

By David Bassanese

Just when investors thought it was safe to wade back into the banks, Moody’s this week saw fit to act on its lingering “negative credit watch” and marginally downgrade their long-term bank credit ratings.

To be specific, Moody’s dropped the banks' long-term rating a notch from Aa2 to Aa3. Is this a cause for shock and alarm? 

Not really, in my view. Australia’s major banks remain among the most profitable and well-capitalised on the planet, and – thanks to the recent bank levy – are now more explicitly than ever protected by an effective government guarantee against insolvency.  

In fact, since the financial crisis, banks have increased their capital buffers and reduced their reliance on short-term offshore funding – so much so that their return on equity has accordingly taken a modest hit.

What’s more, Moody’s action only appears to have brought their bank ratings more into line with other credit rating agencies such as Standard & Poor's and Fitch, which cut bank ratings some time ago.

And reading through Moody’s statement, it’s hard to see what all the fuss is about. While concerned about recent strong house prices gains in Sydney and Melbourne, Moody’s shares my assessment that a “sharp housing downturn” remains unlikely. It also notes that – at current interest rates at least - mortgage affordability remains good for most borrowers.

The banks effectively face guilt by association. Moody’s is red-hot on concerns about high household debt, weak incomes growth, and the risk of a major decline in consumer spending reverberating through the economy if interest rates were required to rise quickly and/or the unemployment rate leapt higher. In a sense, high household debt has increased the vulnerability of the household sector – and by consequence the economy – to unexpected shocks.

That said, while we should never discount the risk of a serious shock sending consumer spending south, it’s still hard to envisage a scenario which would generate such a worst-case scenario. After all, with inflation and incomes growth so weak – both here and globally – the risk of rapid interest rates increases remains remote. And any negative demand shock to the economy would likely be quickly met by sharply lower interest rates and a bigger fiscal boost from the Federal Government.

Let’s also not forgot that the vast bulk of household debt is still held by older and higher-income households that seem most able to pay it back. And, a big chunk of the debt reflects investment properties, which remains an important investment vehicle of choice for many households thanks to the quirks of the tax system.

Of course, it’s true that household debt as a share of household income has ratcheted higher in recent years – after having levelled out at around 170% for a while following the last greater property boom earlier last decade. However, it’s also true that interest rates have dropped to historically low levels, such that debt servicing costs still remains well below previous peaks.

When interest rates eventually rise again, this higher level of debt will be reflected in a rise in debt servicing costs. But all else constant, that only means the RBA will not likely need to raise interest rates by as much during the next cycle to get a desired slowing in consumer spending. Indeed, due to lower inflation and weaker trend economic growth, it seems likely that interest rates in coming years will average somewhat less than what they averaged prior to the financial crisis.

Somewhat perversely, banks are now being criticised for having increased their exposure to home lending in recent years, precisely because the regulator’s capital rules construed this as a less risky form of activity compared to say corporate lending or financial market trading. 

For good or bad, compared to their global peers, our banks now have relatively simple business models based on home lending funded largely by local deposits. As we don’t really have a housing bubble waiting to burst, banks still seem well equipped to deal with the next evitable down leg in the cycle. 


Can America's economic expansion continue?

Wednesday, June 07, 2017

By David Bassanese

For America’s economic expansion – and hence the global bull market in stocks – to continue, the world’s leading economy will sooner or later need to produce something that has eluded it since the financial crisis: decent productivity growth on the back of labour-saving business investment.

The good news is that, given America’s ingenuity, I suspect this will be a natural outcome of growing labour shortages, which will give the expansion a second wind without overly stoking inflation.  

The bad news is that it could also mean the next equity market bust, when it comes, could reflect a valuation bubble. 

So far at least, America’s long economic expansion has been top heavy, with jobs growth rather than productivity growth – such that the unemployment rate has now dropped to a very low 4.3%.  

Non-farm business sector: Real output per hour of all persons 


Judging by business surveys, however, labour shortages across the economy are intensifying. Indeed, some of the slowing in employment growth in recent months likely reflects growing labour scarcity. Ordinarily, labour market tightness should result in higher wage growth – and hence higher inflation – which causes the Federal Reserve to more aggressively jack up interest rates and bring the economic expansion and Wall Street’s bull market to a shuddering halt. 

That might still be an outcome – but there’s little evidence of it yet. Indeed, last week’s May payrolls report revealed that average hourly earnings remained fairly benign, with annual growth steady at only around 2.5%. Due to the lack of pricing power it seems, few companies are able to attract the workers they need simply by jacking up wage rates.  

Another scenario is that America’s expansion simply exhausts itself – a victim of its own success. Unable to raises prices to pay higher wages and attract needed workers, corporate America’s might simply lower their ambitions. Given low US productivity growth and population ageing, only around 100,000 jobs a month going forward would be needed to keep the unemployment rate steady. That would represent a marked slowing in the pace of employment growth compared to what has been enjoyed in recent years, and could risk continued gains in corporate profits. And, given the way multipliers work through an economy, a modest scaling back in ambitions could result in a more serious slowdown. 

Neither rising inflation nor reduced corporate ambitions are desirable – and thankfully I don’t think likely outcomes. Given global competition and new technologies, it is hard to see corporate pricing power rise to an extent that America develops a serious wage and price inflation problem. But nor do I think American business will simply roll over and close up shop. Rather, given necessity is usually the mother of invention, it would not surprise me to see more labour-saving productive investment and/or “re-engineering” of business processes.  

Indeed, there are some suggestions that recent persistent low inflation and weak productivity growth already reflect such labour saving innovations in the services sector – only our old fashioned manufacturing-based means of measuring economic growth can’t properly capture it. If so, it could be that a further step-up in business labour saving innovation in fact results in lower inflation – which effectively continues to support economic growth by boosting the real incomes of workers. 

In Japan, for example, inflation remains very low even though the economy has been running ahead of potential and the unemployment rate is also very low. As for the Bank of Japan, such a development in the United States would leave the Fed in a quandary over whether to continue lifting interest rates or not. 

All up, either way America’s long economic expansion will end at some stage. It is said that expansions (and equity bull markets) rarely die of old age – rather higher inflation or a bursting asset bubble close the party down. Absent a decent rise in inflation, I suspect it will be an eventual asset bubble, likely in the tech sector again and helped by central banks wrongly fighting productivity-induced low inflation - that leads to the next global bust.  

The party could again eventually end in tears, but there seems a little more dancing to be had before then.



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