Australian dollars impact on property prices

50% of the time, all the time.

RBA is signalling higher rates and a property downturn…

• What’s on our mind: RBA getting grilled by the House of Reps - we read between the lines… 

• What happened this week: US inflation rate came in at 8.3%, AUS unemployment rate was up 0.1%, Phillip Lowe got grilled by the House of Reps.

• What are we watching next week: US Fed cash rate decision, UK cash rate decision, RBA meeting minutes.

Prelude:

What’s on our mind:

This week, The head of the Reserve Bank of Australia, Philip Lowe was questioned by the House of Representatives economics committee.

For a quick sentiment check, have a read of the following quotes from governor Lowe:

On interest rates:

• "2.35%, I think the rate is still too low”

• “I think we'll cycle around some number between 2.5% and 3.5%”

• “It would not surprise me — and this is not a forecast — it would not surprise me if prices came down by a cumulative 10 per cent”

On property prices: 

• We don't want to forecast housing prices, because it's very, very difficult to do, but as interest rates rise further, and they will rise further, I'd expect more heat to come out of the housing market and prices to come down further”

• The fact that Australians have to pay high prices for housing isn't anything to do with the Reserve Bank over a long period of time”

• "It's the choices we've made as a society that have given us high housing prices”

That last quote is a particularly interesting call from the governor. 

Is it the choices we have made as a society or was society coerced into these decisions? 

Looking at the direction of property prices after the RBA started cutting interest rates in the 1990’s, we think it isn’t a societal view that was formed organically. 

Rather, it is a societal problem induced by cheap borrowing costs and a swathe of government incentives to push more and more capital into the property markets.

From policy’s like negative gearing, to tax depreciation benefits on investment properties, to more recent stimulus measures like homebuilder grants and shared equity schemes. 

It is the government and the RBA that is responsible for creating the property addiction in Australia. 

We think that governor Lowe blaming society, as if it was an organically formed view is almost as bad as his call for no rate hikes until 2024. 

A retrospective view of the questioning:

Lowe tried to focus on three core topics for the entirety of his question time. The three topics were:

1. The decline in unemployment.

2. The surge in inflation.

3. The earlier and sharper-than-expected increase in interest rates.

Taking a step back, after listening to almost ~3 hours of questioning, our “read between the lines” view of the discussion was that governor Lowe and the RBA really only care about two measures:

1. The AUD/USD exchange rate - Ultimately, this impacts domestic inflation, the lower the AUD exchange rate is, the higher inflation is. We think the RBA will increase rates depending on the direction of the AUD exchange rate i.e as the AUD weakens, the cash rate needs to rise and vice versa. 

2. Housing prices - This is the ultimate barometer of healthy credit markets in the domestic economy for the RBA. If housing prices fall hard and fast, credit markets will freeze and banks will stop lending. This is almost a worst case scenario outcome for the RBA and we would expect intervention almost immediately if this was to occur (likely through quantitative easing).  

Today we will touch on the first of these - the AUD/USD exchange rate.

We will detail the things we are watching and how we think the RBA will respond to a change in conditions. 

To preface today’s article, our base case view is to see further depreciation in the Australian dollar, led by commodity price falls. 

Ultimately, we think this will lead to higher inflation rates and then force the RBA to continue increasing interest rates. 

Before we get into it, for those that want to see the full ~3 hour questioning, click on the image below. 

The AUD/USD exchange rate:

Why does this matter?

A lower AUD exchange rate relative to the USD means higher domestic inflation.

First because more Australian currency is required to purchase foreign goods and second because the cost of energy (input cost for everything) increases in Australian dollar terms. 

One way the RBA tries to control the AUD exchange rate is by increasing the RBA cash rate trying to spur more demand for Australian dollars in the international markets. 

In fact the RBA has the maintenance of a stable currency as one of its core principle duties:

What does this mean? 

As the AUD exchange rate depreciates, there is more pressure on the RBA to increase its cash rate more aggressively. 

Right now the Aussie dollar is trading at 67c against the USD. 

Our view is that as the exchange rate falls to ~60c or lower, the pressure will start to mount on the RBA to raise rates. 

What indicators are we monitoring to workout the direction of interest rates?

There are two main things we are watching. 

1. The RBA cash rate relative to other central bank policy rates - If the RBA’S cash rate is lower than other developed economies the AUD will continue to depreciate. 

This one is fairly easy to track, by following the policy decisions central banks in the US, Japan, Canada and the Euro area are making. 

At the moment, the RBA cash rate is at 2.35%, below that of the US, Canada, NZ, and many other developed economies. 

So long as this continues we expect the AUD to weaken further.

2. Demand for our main exports - Higher exports means a stronger dollar and vice versa. 

For this, we are tracking the commodity prices for Australia’s three largest exports.

First is Iron ore prices (making up ~15% of AUS exports). 

Iron ore prices are down ~33% over the last 4 months…

Second is Coal prices (making up ~15% AUS exports). 

The coal price remains relatively strong, which explains some of the AUD exchange rates resilience.. Of course this will change very quickly if coal prices start to fall.

Third is Liquefied Natural Gas (LNG) prices (making up ~8% of AUS exports).  

LNG prices have fallen off a cliff by almost 60% just in the last few months. 

Our view:

If our main export prices start to fall AND the RBA continues to lag other central banks with respect to the pace of interest rate rises, the AUD will continue to depreciate.

Eventually, this will come back to haunt the RBA and force more rate hikes at a time when the central bank can least afford it. 

Our base case view is to see further depreciation in the Australian dollar, led by commodity price falls and eventually higher domestic interest rates in Australia. 

Our Newsletter:

For those who are reading this blog for the first time, we put out a newsletter every week on a Wednesday where we put together a wrap-up of everything property across the markets. 

In our newsletter, you can find the following: 

• Our property data wrap for the week.

• The feature article for the week 

• The chart of the week