Storm Clouds or Fog? The Housing and Mortgage Rate Forecast for 2019

Housing Market Written by John Bolton, Oct 30 2018

There is an increase in news stories postulating a property crash. Prices in Sydney have declined by 7.40% compared to same time last year, and prices in other global hotspots are under pressure. So what about NZ? Time to cut through the noise, try and make sense of what’s going on in the world, and explore what could happen with house prices and mortgage rates in 2019.

The Global Story

Let’s start big. Emerging markets like Turkey, Argentina, Pakistan, Malaysia, South Africa, and Indonesia have borrowed heavily in US dollars, at a time when interest rates were very low. Over the past ten years emerging-market debt has risen from $21 trillion in 2007 to $63 trillion in 2017! The problem for emerging markets now is that US dollar interest rates are increasing and the US dollar is appreciating. Both drive up servicing costs for countries that have US dollar denominated debt. This will not end nicely.

The US economy is growing. That’s because Trump is applying lots of fiscal stimulus on top of monetary stimulus. That is working in the short-term, but will exacerbate the problem when all of this stimulus is removed. The question for Trump is whether he is building sustainable growth. With trade-wars and protectionism I doubt it.

Global Politics

The global story at the moment is fascinating and attention grabbing. It’s like a high stake game of chess. The impact on NZ really only comes about if the game goes bad. That’s not likely but still possible.

China is welding a lot more influence in the pacific as part of its pacific belt strategy. That’s quite visible in the pacific islands but maybe also in NZ? The US call it debt diplomacy and it has them starting to fight back. In May, New Zealand was labelled the ‘soft underbelly’ of the five eyes spy network due to growing Chinese influence in politics.  

My perspective of the Pacific Belt strategy is that the goal is to reduce resistance to a more assertive China. For example, China’s military expansion in the South China Sea and in particular in the Spratly Islands. Just this week there was a dangerous stand-off between a US Destroyer and Chinese warship that went largely unreported.

Don’t underestimate the tension building up between China and the United States. Historically China has had a free-ride on a liberal globally orientated US. Under Trump that has changed.

At the same time, we have the US and Turkey dancing around Saudi Arabia’s killing of Jamal Khashoggi (a US permanent resident) on Turkish soil. The US will care more about its arms deals to Saudi Arabia than international law and this will undoubtedly be covered up or deflected.

The US will continue to wage a trade war with China. At the same China is having to deal with a non-bank sector that is over leveraged and year’s on mal-investment in infrastructure. President Xi Jinping is centralizing power to orchestrate a soft unwind of Chinese excess. His fight on corruption has seen more than 1 million officials disciplined with some high profile disappearances like the Chinese president of Interpol.

Somewhere in the mix Putin is poisoning former spies on UK soil and influencing US elections.

At some point, Trump will wage war (or not far short of it) with Iran as a matter of political survival – he needs a suitable enemy and Iran ticks the boxes. I also wonder if it’s helpful that Iran is conveniently an enemy of Saudi Arabia.

The UK is exiting the EU, arguably poorly, and Italy isn’t in great shape with a populist party and high debt levels.

None of this is unusual. Arguably, the world is as peaceful as it’s ever been. It does feel however, that we’re collectively in a weaker position to respond to the next financial crisis.

New Zealand’s egalitarian values resonate strongly with younger generations and make us an attractive country for talent. The world is rudderless and full of corrupt self-serving leaders, which is getting worse. We could use our attraction and genuine talent to transform our economy. We should not be selling citizenship for money or bringing in low skilled immigrants to support legacy low-growth low-wage industries. If ever there was an opportunity for us to change our future, and improve incomes it’s now, but we won’t.

Markets

Share markets indices are well cooked, property prices are high and over-leveraged, global debt levels are high, and corporate debt yields are low relative to risk. We have too much debt and we’re poorly investing all this cheap money.

This has started to play out in share markets over the recent months. The NZX50 dropped 3.60% in one day this month and the market has become generally bearish.

As US interest rates go up and as risk goes up, we can expect liquidity to exit. That means more sellers than buyers. Deleveraging (paying back debt) sucks up money and is going to curtail global growth. Debt fueled growth is fundamentally unsustainable. We have sucked up so much of our future growth potential to keep the party going. At some point we have to accept and work our way through this hangover.

With the share market, price-earnings ratios are well above their long run averages. In other words, share prices are too high. The theory goes that increasing interest rates in the US will hurt share prices.

Low growth (from deleveraging and trade-wars) will eventually translate into poor earnings growth for business. Both low profit growth and higher interest rates will at some point undermine current company valuations. I suspect that will be especially true of technology stocks whose valuation bear no resemblance to actual financial performance.

It is therefore increasingly likely we will have a share market correction in the next year or so, but nobody is going to accurately call these things. I’ve been waiting for a correction for over two years!

Ditto debt markets. Bond markets have been in a 30-year rally with falling interest rates, but that is coming to an end. Excess money supply has seen debt priced cheaply with US Corporate credit margins at 1.85% over US Treasuries compared to over 3.00% during recessions. Corporates are going to get hit from all angles – obscure politics, poor earnings growth, higher debt costs, and higher discount rates.

Bringing it home – what does that mean to me?

Us Kiwis are reasonably lucky because we are a small low-growth economy with relative stability. The story I always come back to is the rabbit and the tortoise. Sometimes it’s good being a tortoise!

It was good to see our Government bank a surplus and not come out with excessive spending promises. We need a Government that is focused on reducing debt-levels, so we have capacity to stimulate the economy when we really need it. That should last this current term and at least half way into the next one. At some point our political parties will start to throw around ‘bribes’ but we’re still a long way off that.

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Our share market is also high, but it doesn’t feel that frothy. Unlike 1987, our companies these days actually do things relatively well. We don’t have much of finance company sector and most bank lending is on relatively conservative terms. The NZ dollar has also weakened which further strengthens our terms of trade with the world.

Off the back of the 2007 GFC, our Reserve Bank introduced a core funding ratio which has forced banks to fund themselves far more conservatively and to hold more capital. More recent LVR restrictions and other credit tightening policies have taken the edge off the housing market. Whilst other may debate it, I think our banks are in good shape and that will be important.

House Prices

Prices have softened in Auckland especially in higher price brackets. This will continue with a backdrop that includes global uncertainty, low business confidence at home, as well as changes impacting overseas investors, and generally tighter credit conditions. Downward pressure on house prices tends to flow down the market as each tier in the market resets its expectations. My view is that prices in previously hot parts of Auckland are off their highs by about ten percent. For now, that translates to an unofficial drop of around five percent. According to QV data which lags the market, Auckland prices were down 0.50% in the last quarter, so 2% annualised. Expect to see similar news over the next year. Also factor in that a lot more sales are going to occur in lower price brackets with KiwiBuild encouraging development below $650,000.

That’s not a crash, it’s simply a soft market and fundamentally we still have low interest rates and low unemployment.

House sales volumes have been below long-term averages for years and are still low. On a per-capita basis September house sales were as low as the GFC. At the moment, low sales has not transferred to falling prices. (For more on that, check out this article). The longer this goes, the more I’m convinced we can ease our way through this with a soft landing.

If you think about long-term property investing, a simple rule is to not over-leverage yourself. Investors will only lose money if they are forced to sell into a weak market. Carrying too much leverage in this market is plain dumb.

I’m not worried about house prices. Yes they are high, but I don’t see anything that would result in them crashing and the long-term prognosis for New Zealand is good.

What about Australia?

It very easy to draw a comparison with Sydney or Melbourne but they are different markets. Most of the issue in Australia is stemming from an over-build of apartments which is flowing into the market. Along with that is the impact of tighter credit conditions. Bear in mind that Australian borrowers have been doing 95% loan-to-value mortgages until recently. In contrast, Auckland price growth has been flat for two years with tighter credit conditions and much lower building activity.

Mortgage rates

Mortgage rates will stay relatively low. That said, the cost of borrowing will blow-out when the world tips into its next recession. We also need to face the prospect of a much lower NZ dollar putting upward pressure on interest rates. Nonetheless, I still see mortgage rates staying in the 4%-5% range for the foreseeable future. They will increase slightly off current lows so I find the 2 and 3 year part of the curve attractive. We are currently getting 3 year fixed rates at 4.39% and 5 years at 4.85%. If you want to find out how much you can borrow or calculate what your repayments would be, then give our mortgage calculators a whirl.

Longer term outlook

The good news for New Zealand is that we have favourable demographics, we’re well located and well resourced.

South East Asia has a young population that will become an economic power-house and also drive the next resources boom (not dissimilar to China over the past decade.). But, the emerging markets crisis (from too much US$ debt) means there will be economic pain in Asia before that happens.

New Zealand and Australia are well positioned for the next growth story coming out of South East Asia. We have an open-economy, free-trade agreements, an attractive business environment, proximity, and a strong agricultural resource base.

We can help. Have a chat to one of our advisers.