Market Report

FONGO Down Under

by Christopher Wood / Mar 21, 2019


GREED & fear encountered a new acronym while in Sydney recently. FONGO, or “fear of not getting out”, was the subject addressed in a newspaper article on falling home prices in Australia. While most investors GREED & fear met in Australia do not expect increased selling pressure if buy-to-let investors start selling, the risk is clearly not zero.

Falling house prices
There is a lot of residential property in Australia owned by investors, encouraged by the tax deduction on the negative carry on investment properties, and this looks a much less attractive proposition when prices are falling, particularly as the Labor opposition is campaigning on removing for new purchases the negative gearing tax deduction on investment properties. Labor is still expected to win the general election due to be held no later than 18 May. A poll conducted on 6-11 March by Essential Research shows Labor with a two-party lead of 53-47 against the ruling Coalition.

Tough serviceability calculation
Meanwhile, one point is very clear to GREED & fear. Australian housing-loan commitments are likely to keep plunging so long as banks keep assessing a borrower’s ability to service a mortgage on an assumed 7.25% borrowing rate even though it is now possible to get a mortgage at a market rate of
3.55%. This tough “serviceability calculation”, combined with much tougher scrutiny by banks of what a household spends a month, means the number of people who can qualify for a home loan collapsing, most particularly as banks also now want to see 25% equity in a home loan. As a result,
Australian housing loan commitments declined by 20.6% YoY in January, the biggest decline since
November 2008. And so long as lending keeps declining, house prices are likely to keep falling.

Risk aversion
If the banks have now gone into classic risk aversion mode, GREED & fear has heard that the
Reserve Bank of Australia is pushing for the minimum 7% stressed borrowing rate to be lowered.
However, the Australian Prudential Regulation Authority (APRA), the banking regulator, is resisting because its mandate is less about boosting the economy than preserving the health of the banking system, and never forget that the four major Australian banks have an average net loan-loss provision of only 12bps.

Are more rate cuts coming?
Still one way the central bank could get that assessment rate for the serviceability calculation lower would be to cut the policy cash rate from the current all-time low of 1.5%. The RBA again missed a chance to cut at its monetary policy meeting on 5 March, while the three-year government bond yield has fallen below the cash rate. But policy rate cuts are coming sooner rather than later as the RBA will inevitably panic even if it is true, as has been highlighted by CLSA’s Australian bank analyst Brian Johnson, that rate cuts will not be fully passed on to home borrowers. Certainly the money markets now understand that more rate cuts are coming, even though the RBA is still officially on “neutral”. Money market futures are now discounting 50bp easing by 1Q20 whereas when GREED & fear was last in Australia, the money markets were assuming the next move in monetary policy would be a tightening.