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Issue 19: September 09
Interest rate update >

Economic Comment >

With rates at an historical 25 years low, its obvious to all that the next interest rate move will be up. The big question is WHEN? 

The RBA has consistently indicated that it considers a neutral position for the Official Cash Rate (the rate the Federal Government pays for money) is approx 5.00% .

It has also stated quite clearly that the current low rate is abnormal due to the global financial crisis.  

What does this mean for us?

At the moment the Official Cash Rate is 3.00% - and the average variable rate home loan is approx 5.50%  - ie about 2.50% higher than the Official Cash Rate.

Therefore in normal conditions the RBA is indicating that the “average” variable rate home loan should be in the range of 7.50% to 8.00% per annum. 

How quickly will interest rates rise?

This is the proverbial question. Most economists are suggesting that the rates will rise by 1.00% by the end of 2010, with a further 1.00% increase by the end of 2011. Its expected that the first increase by the RBA will be in February 2010.

Should you fix rates now?

It’s a matter of personal decision —however, the current average 3yrs fixed rate is 7.14%. 

 It could take more than 2 years for the average variable home loan rate to reach this level…...

 

 
Economic Comment - Focus on the USA
Australia  

If we take notice of the press and the Federal opposition at the moment we could be forgiven if we thought that the Global Financial Crisis and worldwide recession were just a brief bad dream that’s already passed Australia by, and that its time for the Federal Government to stop stimulating the economy.

As a nation we seem to have escaped the worst effects of the global down turn to date. Unlike previous down turns there haven’t been mass sackings, retrenchments and large factory closures.

In the real world we all know individuals who have had their lifetime savings slashed or quarantined, who have lost their jobs, or have had their working hours reduced. Some were affected very early, some are only now feeling the effects.  

We have the previous federal government to thank for their prudent financial management over their last terms of office. We have the current federal government to thank for quick and decisive intervention on a massive scale.

Finally we have to thank our close ties to the Chinese economy.

We may have won the first battle—but have we won the war? Two years ago we failed to see the problems emerging in the US

United States - some disturbing trends with possible global impact - (data courtesy of Bloomberg, Financial Times and The Economist)

Despite the growth of the Indian and Chinese economies, the fact remains that at present the US is the economic powerhouse of the world economy. One in every five dollars spent in the world is spent by the US.

There may be “green shoots” but they’re growing in poor soil…….

Behind the hype and headlines the reality is that the US economy is not mending fast. It’s still suffering massive aftershocks, and will take a long time to return to normal. If we look at the historical perspective of the Great Depression which started with the share market crash of 1929 -it took until the end of WW2 for the US Economy to surpass the 1929 level ie 16 years.

· It’s estimated that the every one of the 130 million US households has had their net wealth reduced by $54,000 or a total of $7 trillion ($7,000,000,000,000).

· Unemployment in the US is currently 9.7% - a record high but the hidden unemployment is much higher.

· Unemployment is significantly higher in the major cities particularly amongst the black and Hispanic communities.  - up to 22.6% in El Centro California

· More than 2.3 m workers have “given up” on finding new jobs

· Part time employment has increased by 50% to 8.8 million workers

The average working week is only 33 hours - the lowest on record

The United States  - Continued

Housing market (www. economist.com  - 29 August 09)

There are tentative signs of stabilisation in the US housing market.

· Sale prices increased marginally in May - the first increase in 34 months.

· Construction of new homes rose in July for the 5th straight month.

· Sales of existing homes (number of properties sold) increased in August for the 4th straight month.  

However there’s a downside to the numbers

· The increasing number of new homes adds to an already oversupplied market.

· Mortgage foreclosures / notices of default in July were 360,000 - a new record.

· In the 7 months to July 2009 over 2.3 million notices were issued.

· Defaults by borrowers with prime (the most credit worthy) mortgages are rising faster than defaults by borrowers with sub prime mortgages.

· One in four sales of existing homes is a repossession (mortgagee) sale.

· Its estimated that at present 23% of homes with mortgages have negative equity— i.e.  the owners owe more on their mortgage than the house is worth. Its estimated that up to 25 million US homeowners could be better off “walking away” from their homes and debts.

· By 2011 Deutsche Bank estimates that negative equity will peak at 48% of total homes. 

What are the implications of these problems?

In the past Americans have borrowed heavily against their homes to maintain lifestyle.

With negative equity in their homes, and underemployment consumers can’t  borrow, they can’t buy new vehicles, appliances and lifestyle assets. Most can’t even refinance or consolidate their current debts. 

By itself negative equity in a property is not a major problem - as long as the borrowers have the capacity to continue servicing the debt. If the borrower can no longer service the debt and the mortgage is foreclosed, the negative equity will be realised.

The combination of high levels of unemployment / underemployment combined with high levels  of negative equity indicate that there are still major problems to come.

· A downwards spiral could be created leading to a collapse of the US real estate market.

· Similarly with retirement savings hit hard the stock of investment capital could shrink significantly with major adverse effects on the US and global capital markets.

In Summary

Once we look past the headlines, the real story is starkly different. Before we start celebrating our Australian “great escape” - we perhaps need to look a little closer at our trading partners as well as our own circumstances.