The Valor Blog.
Investment News and Views, Direct from Our Team.

The RBA just lost control of the Australian Economy

On Tuesday the 2nd of August, the RBA lowered interest rates from 1.75% to 1.5%. Then the most unexpected moves by the banks indicated that what the RBA does from here has very little meaning.

After the 0.25% drop, the banks put their deposit rates up by 0.5 to 0.85%. This increase in funding cost for the banks after only passing on 0.13% cut to rates is the equivalent of a roughly 25% fall in their net interest margins of 2%.

The banks have effectively just lowered profits for mortgages by around 25%. If you own bank shares in Australia, I would be reviewing the quality of those temporary “juicy” dividends. For the yield addicted retirees, this news is the blow that they can’t afford. (See European banks for what is more likely than not from here)

Tuesday was the crack in the San Andreas Fault, that is the extremely leveraged Australian property market.

The proverbial straw that breaks the camels back can’t be far away with much greater risks to our economy that any time in the last few decades thanks to China’s monstrous $35 trillion debt bubble.

The property market has not corrected over the last few years as we expected. This does not mean that we are going to be permanently wrong on the eventual outcome. It means that when it eventually rolls over, the correction will be larger than it otherwise needed to be. Most estimates for falls in prices are not even close to what has happened in history to every property bubble of this magnitude. There are no exceptions.

Read about Japan in 1989, Hong Kong in 1998 and Ireland in 2007 as these bubbles are the only bubbles that have ever reached these lofty heights of above 3.5 times the size of the economy.

We are now atop a $6.5 trillion property market for a $1.6 trillion economy, possibly the largest in world history, with no effective interest rate bullets left in the reserve bank chamber.

“Be fearful when others are greedy and greedy when others are fearful” (Warren Buffett). Australia is likely the greediest property market that has ever existed. Discussions on the topic engulf dinner party conversations and Uber ride discussions (formerly the taxi driver bubble test).  Whilst we cannot know exactly when it will become very ugly, we can know that we should be more fearful than any time in the history of property markets (and act accordingly by selling all related assets that are solely dependent on higher household debt levels.)

Lower interest rates in Europe are delaying the inevitable, however with the 230,000 housing starts in Australia with a need for less than half this number, a very Irish type scenario is developing quickly. The oversupply is already leading to zero or no rental growth and will continue to get worse over the coming year. At some point in time, investors will face lower rents, higher vacancy rates and falling prices.