Australian House Prices Could Fall Twenty Percent

Feature Stories | Sep 29 2022

The US Federal Reserve’s policy aggression will force the RBA into further rate hikes that will potentially lead to a bigger house price fall than previously feared.

-Fed hawkishness shakes up global central banks
-Chance of RBA slowing down has receded
-Morgan Stanley forecasting -20% fall in house prices
-Will Australia see a recession?

By Greg Peel

Following the July Federal Reserve meeting, Wall Street sensed a slightly more dovish tone to Jerome Powell’s rhetoric, leading to the assumption the Fed would at least begin to slow the pace of rate hikes, or even pause, and perhaps “pivot” (cut rates) in 2023. As a result, the S&P500 regained 50% of what it had lost year to date.

It would appear Powell was rather incensed by this interpretation, if the implicit rebuke Wall Street received for this misguided view at Jackson Hole in August is anything to go by. Wall Street turned and began falling back again, expecting further excessive rate hikes. When US August inflation data shocked to the upside, Wall Street tanked, then headed to new 2022 lows.

As a result, economists have scrambled to upgrade their expectations of the Fed’s “terminal” rate target – the rate at which the hikes would stop. At the September meeting, FOMC forecasts suggested that rate would be 4.6%, up from the 3.00-3.25% rate suggested previously, following another 75 point hike.

Economists have also lifted their expectations for rates in Australia and across the globe.

The Fed has led the monetary policy aggression as it seeks to crush inflation, as evidenced in a surge in the reserve currency to twenty-year highs. While other central banks have also been raising rates to curb inflation, they are now forced to also step up the aggression to keep pace with the Fed, lest their currencies collapse and even more inflation is imported.

Witness the UK pound, which had fallen to its lowest level ever against the US dollar, prior to Bank of England intervention, following a shock policy release from the new government which included tax cuts and a spending bonanza despite an already huge budget deficit, intended to save the UK economy.

These fiscal policies only put more pressure on the Bank of England to hike its cash rate.

NAB economists have raised their Fed terminal rate expectation to 4.00-4.25% from a prior 3.50-3.75%, bringing it in line with general market consensus post the September Fed meeting.

Westpac economists expect 4.125% (midpoint of 4.00-4.25%) by the end of this year.

Barrenjoey economists see 4.25-4.50% by year-end, and another 25-50 points of hikes in early 2023.

ANZ Bank economists are forecasting a Fed terminal rate of 5.0%.

“Our new 5.0% peak for the fed funds rate is substantially restrictive, raising the risk of a harder landing for the US economy. These risks are even higher given central banks have allowed policy to disconnect from economic improvement over 2020 and 2021. Opportunities to pause hiking to assess the impact of already delivered interest rate increases are limited.”

While 5% may be considered an outlier among forecasts, there is agreement among economists that because the Fed was so slow to react to surging inflation, it has to go hard and go fast to catch up. Given the impact of rate hikes typically filters through the economy with a lag of six months or more, typically a central bank would pause to assess that impact before making the next move, but the Fed does not have that luxury.

Many fear, nonetheless, the Fed will go too far, too fast, and will be forced to cut rates later in 2023 in the wake of a deeper US recession than feared. While the Fed appears to have abandoned hope of a “soft landing” – Powell warning of “pain” ahead – the FOMC will still want to keep that pain to a bearable level.

And the RBA?

If the Fed hikes, the RBA has to hike too. Already the Aussie dollar has fallen to 2020 covid lockdown levels.

However, the Australian dollar has only fallen against the US dollar, and is higher against other currencies. This, suggests Barrenjoey, should mitigate the impact of imported inflation.

The RBA’s cash rate is currently 2.35% compared to the Fed’s 3.125% (at the midpoint). While this might imply the RBA had better catch up fast, economists agree demand- and wage-pull inflation pressures are materially lower in Australia.

While it’s back in the mists of time, the last Australian headline CPI reading was 6.1%, and the RBA is forecasting a peak of 7.75%. The US CPI peaked at (we assume) 9.1% in June and was 8.3% in August.

The impact of higher rates on households is also different in Australia compared to the US. The bulk of US mortgages are fixed for 10-15 years. The bulk of Australian mortgages are on variable rates, and those that are fixed are only 1-4 years in duration. The RBA thus knows it has to tread carefully, hence the board considered only a 25 point hike in September before settling on 50.

It was then expected perhaps October would only bring a 25 point hike, but that was before US August CPI result and the September Fed meeting. Most economists now expect another 50 points in October.

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