Jerome Powell has had his wet finger in the air for months now. And he’s only now starting to feel a cool breeze coming from the south.
The data are ‘not currently sending a signal that we need to move in one direction or another in my view,’ he said.
The US Federal Reserve has trimmed their growth expectations. In December, the monetary wizards believed the US economy would grow by 2% in 2020. Although today, these fortune-tellers believe growth will be lower than that.
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There likely won’t be any more rate hikes this year — unless another cool breeze catches Powell’s finger, of course. And this decision to hold interest rates where they are didn’t really help out anyone.
Stocks rallied a bit, but not much. Bond yields and prices are more or less unchanged.
The worst part is, we have a monkey see monkey do mentality among central bankers. If it’s good enough for the Fed, then it’s good enough for us.
While I’m sure our own Reserve Bank of Australia (RBA) is more concerned with Aussie figures, we seem to be going the way of the US. Aussie rates have been on pause for years. And the next move might potentially be down.
Should that happen, could we see another run up in housing prices?
We shot a video this week, where my colleague Selva and I discussed this very question. But it wasn’t just limited to home turf, we talked about central bankers over in the US, Europe and even Japan. You can hear our thoughts and watch our discussion by clicking the picture below.
Interest rates are half the equation
There are two sides to this coin: the price of money (interest rates) and the quantity of money.
I’d argue that the latter is the more important part. Cheap money doesn’t make people borrow all by itself.
Investors and borrowers have to feel confident to borrow. They need to feel like they could make a decent return on their money. Otherwise, why would they bury themselves in debt?
Along with borrower confidence, lenders also have to be confident to lend. They are the ones risking capital, after all. Even if it is just printed money, coming from nowhere.
How do you think Australian property prices ran up in 2017?
Interest rates were low. That helped. But what was more important to the rise, I believe, was the amount of money being created by banks to fund these mortgages.
Up until 2017, there was overwhelming demand for mortgages. Banks were all too happy to oblige.
They stretched serviceability numbers, they took on deposits of 10% instead of 20%. They flooded the mortgage market with cash.
And so there were all these cashed up Aussies willing to outbid each other at auction.
Like I said, cheap money had its role. A recent study from the RBA decided to look at the direct affect interest rates had on property prices. What the paper found was that a 1% fall in rates could boost house prices by 17%.
The ‘reduction in real interest rates…accounts for most of the subsequent boom in dwelling prices,’ the authors wrote.
Despite that, it wasn’t higher interest rates that brought prices back down. It was regulators restricting the quantity of money going into the mortgage market.
Ask the RBA today and they’ll likely say the housing risks are ‘contained’. And, of course, they had nothing to do with it. The RBA isn’t at all worried about 80,000 new apartments about to be dumped onto Sydney’s skyline, either.
From the Australian Financial Review (AFR):
‘Risks to financial stability from the huge wave of apartment building and a run up in commercial property prices has become “elevated”, Reserve Bank of Australia assistant governor Michele Bullock told property developers in Perth on Wednesday.
‘…More than 80,000 apartments have been completed in Sydney over the past few years, adding roughly 5 per cent to the city’s housing stock, while in Melbourne and Brisbane there have been relatively large additions to the supply of apartments.
‘This has created two key risks. The first is to household balance sheets, where buyers have purchased off the plan but, on completion, the value is lower and they have to draw more on their savings or loans from other sources.
‘The second risk is to developers who are delivering completed apartments into the cooling market and are exposed to increasing settlement failures from households who can’t afford to go ahead with their purchase.’
As I explain in the video with Selva, I don’t think it’s likely the RBA will cut rates and cause house prices to stampede upwards. I think the banks will be less willing (they’re now being forced to be more unwilling) to create new money for mortgages.
So, we’ll probably see prices continue to come down slowly and find a new normal.
How much power do central bankers actually have?
As I mentioned before, people don’t borrow and invest just because money is cheap. They borrow and invest because they think they’ll get a decent return on their money.
The empirical studies show no relationship between interest rate changes (within a narrow margin) and the propensity to borrow. I’ll include a few choice words from Columbia Business School professor, Bruce Greenwald…
‘All the empirical evidence we have is that interest rates within the range of variation we see do not affect investment. Investment is driven by perceptions of risk and accelerators in demand that drive the demand for investment. So it’s not a surprise I think that the zero interest rates have not stimulated investment. Because nobody has ever been able to find a significant interest rate effect on investment.’
So what the hell are central bankers doing? If changing interest rates does nothing, why do they bother using this blunt tool at all?
Maybe the financial world doesn’t want to accept that some of the most powerful men in finance are actually ineffectual intellectuals, playing with their models and spreadsheets, inflating asset prices.
‘What we used to have in the United States was a regulated ceiling of zero percent interest on demand deposits. That was a tax on depositors and a subsidy to the banking system.
‘In fact, what it meant was since they never reduced the money supply deposits were a source of permanent zero interest rate financing to the banking system. And there are other countries, notably Japan, that also did that historically.
‘What that meant was that when the money supply expanded — just ordinary open market operations — and you forced more deposits into people’s hands that was a hidden tax and subsidy system that injected equity directly into the banks. And if what is important is risk absorption capacity not the price of money that greatly increased the risk absorption capacity of banks which meant they would absorb more risk from firms.
‘And the terms on which they lend matter apparently in studies more than the average interest rate at which they lend. That tax and subsidy system went away when they abolished the limit on interest on demand deposits.
‘So I think that one of the things that we have also inadvertently done that is actually showing up for the first time — although you do see evidence of it in the slow recovery from the very mild recession in the U.S. in 1991 — is we have basically disarmed traditional monetary policy.’
This makes a whole lot more sense, doesn’t it?
Injecting banks with equity improves their ability to lend, and therefore increases the quantity of new money created. But what if it all just goes right back into the property market?
This is why I believe we need a central bank that encourages commercial banks to lend for value-added activities — the stuff that produces more new goods and services.
That way you get economic growth, and central bankers actually start doing something again…
Editor, Money Morning