Turbulent times for the global and Australian economies Presentation to ASA/ASX Investor Hour RMIT University, Melbourne th August Saul Eslake Chief Economist
The current global financial crisis stems from the bursting of a credit market bubble From this To this. Cheap and easy money Reduced appetite for risk Distrust of new forms of finance Increased appetite for risk New forms of financial engineering Reduced capacity for leverage Increased capacity for leverage Falling asset prices Rising asset prices Slowing economy
For a time, low interest rates and the explosion in sub-prime lending created boom conditions in the US housing market US housing market indicators up to mid- Mortgage interest rates Housing starts 7 % pa Adjustable-rate 7 Mortgage applications - year fixed rate 'Fed funds' (cash) rate....9.7. Mns (annual rate) 7 Home ownership rate 7 9 Index (Jan-Dec = ) 7 7 9 9 7 % of households 7 Sources: Mortgage Bankers Association of America; US Commerce Department.
Once US interest rates began rising, however, borrowers began defaulting and house prices began falling US housing market indicators Mortgage delinquency rates Existing home sales % of mortgages outstanding 9 days or more in arrears Sub-prime. Mns (annual rate). Prime... 7 Existing houses for sale. 7 Existing home prices........ Mns 7 Jan = Down 9.% from peak 7 Sources: Mortgage Bankers Association; US National Association of Realtors; Commerce Department; S&P (the Case-Shiller index).
and the housing boom turned into a bust, which is continuing despite sharp cuts in the official cash rate US housing market indicators Mortgage interest rates Housing starts 7 % pa Adjustable-rate 7 Mortgage applications - year fixed rate 'Fed funds' (cash) rate......... Mns (annual rate) 7 Home ownership rate 7 9 Index (Jan-Dec = ) 7 7 9 9 7 % of households 7 Sources: Mortgage Bankers Association of America; US Commerce Department.
The US mortgage market meltdown has prompted a tidal wave of losses and write-downs by banks around the world US mortgage delinquencies Losses announced by major banks since mid-7 Dec- % of mortgages outstanding 9 days or more in arrears Sub-prime Prime 7 ABX index of prices of US mortgage-backed securities Mar- 7 BBB- rated Jun- 7 Sep- 7 Dec- 7 Mar- AAA rated AA rated Jun- Sep- Bank Citigroup Merrill Lynch UBS Wachovia Bank of America HSBC IKB Deutsche Royal Bank of Scotland Washington Mutual Morgan Stanley JP Morgan Chase Wells Fargo Credit Suisse Credit Agricole Lehman Brothers Deutsche Bank HBoS Bayerische Landesbank Total (incl. others not shown above) Total (US$ bn)..... 9....... 9... 7.7 7.. 7.7 Sources: US Mortgage Bankers Association; Bloomberg; ANZ Economics & Markets Research.
The IMF has estimated that total losses could eventually reach almost US$ trn, nearly half of which would be by banks 7 Potential ultimate losses on unsecuritized loans Potential ultimate mark-tomarket losses on securities Type of loan Outstanding US$bn Estimated losses Type of security Outstanding US$bn Estimated losses Sub-prime Alt-A Prime Commercial real estate Consumer loans Corporate loans Leveraged loans 7 7 ABS CDOs Prime MBS Commercial MBS Consumer ABS High-grade corporate High-yield corporate CLOs 9 Total 7 Total 7 of which, banks - of which, banks - Notes: Alt-A means low-doc or no-doc mortgage loans. ABS = asset-backed securities; CDOs = collateralized debt Obligations; MBS = mortgage-backed securities; CLOs = collateralized loan obligations. Source: IMF Global Financial Stability Report April, p. ; affirmed in GFSR Market Update July.
Financial market stress has continued and affected the money, swap, bond and share markets 7 Banks short-term funding costs Spread between 9- day wholesale rate and cash* (bp) UK US Euro area Dec- Jun-7 Dec-7 Jun- Dec- Banks long-term funding costs Corporate bond yield spreads Spread over gov't bond yields (bp) Dec- Jun-7 Dec-7 Jun- Dec- Share prices UK US Euro area 7 -year swap spread (bp) US UK 9 Dec = US UK Euro area Dec- Jun-7 Dec-7 Jun- Dec- 7 Dec- Jun-7 Dec-7 Jun- Dec- Note: all data shown as -day moving averages. Sources: Bloomberg; Datastream.
Banks in the US and the euro area are tightening credit standards 9 US banks Euro area banks Commercial & industrial loans Loans to enterprises Net balance tightening standards (%) Net balance tightening standards (%) Large - Small - - 7 7 Mortgage and consumer loans Mortgage and consumer loans Net balance tightening standards (%) Mortgage* Net balance tightening standards (%) House purchase Consumer Consumer - - 7 7 * Weighted average of prime & sub-prime after June 7 Sources: US Federal Reserve and European Central Bank surveys of loan officers.
Oil prices appear to have peaked for now but are still well above their previous high in inflation-adjusted terms Oil prices US$ per barrel Oil price in 7 dollars Forecast Oil price 7 7 7 9 9 9 Note: Oil price is West Texas Intermediate. Source: Thomson Financial Datastream; US Bureau of Labor Statistics; ANZ.
Persistently rising oil prices partly reflecting rapid growth in developing country demand, and flatlining in non-opec output Oil consumption Oil production Mn barrels per day OECD economies (-.% pa over past yrs) Mn barrels per day Non-OPEC Other economies (+.% pa over past yrs) OPEC 9 9 9 9 9 9 99 Sources: US Department of Energy; ANZ.
The US hasn t experienced consecutive quarters of negative GDP growth (yet) US real GDP growth 7 % change from previous quarter (seas. adj. annualized rate) Note: recession did not feature successive contractions in real GDP - - 7 Source: US Bureau of Economic Analysis. Shaded area denotes recession as designated by National Bureau of Economic Research.
The four key indicators used to delineate recession in the US have not yet turned down sharply as in previous recessions NBER s key recession gauges since Sep 7 cf. previous recessions Real personal income less transfers Industrial production.. 99. 99. 9. Preceding cycle peak = Since Sep 7 Average of seven recessions since 9 9 Months since preceding cycle peak.. 99. 9. 97. 9. Preceding cycle peak = Since Sep 7 Average of seven recessions since 9 9 Months since preceding cycle peak Employment Real business sales. Preceding cycle peak =. Preceding cycle peak =. 99. 99. 9. Since Sep 7 Average of seven recessions since 9 9 Months since preceding cycle peak.. 99. 9. 97. 9. Since Sep 7 Average of seven recessions since 9 9 Months since preceding cycle peak Sources: US Bureau of Economic Analysis; Bureau of Labor Statistics; Federal Reserve Board; Commerce Department; ANZ Economics & Markets Research.
The US non-financial corporate sector isn t under the sort of pressures that typically precipitate recessions US non-financial corporate sector % of GDP Corporate profits 9 7 9 9 Corporate debt-equity ratio Interest cover Ratio of profits before interest & tax to net inteterst payments 9 9 Non-farm stocks-to-sales ratio %. %... 9 9. 9 9 Note: Shaded areas denote recessions as defined by the National Bureau of Economic Research. Sources: Commerce Department; Federal Reserve Board; ANZ.
However US household finances are under considerably greater financial pressure than ever before US household sector finances Household net worth % of annual personal disposable income 9 9 Household debt service ratio 9 Household spending on energy % of personal disposable income (trend) 7 9 9 Personal saving rate % 9 9 9 9 Note: Shaded areas denote recessions as defined by the National Bureau of Economic Research. Sources: Commerce Department; Federal Reserve Board; ANZ. - % of personal disposable income (trend) One-off tax rebates
Rising exports, aided by a weaker US$, have more than offset the impact on GDP growth of falling housing construction US dollar, exports and housing Exports of goods and services Exports and housing Real % ch from (trend) - - - 9 9 Cumulative change since Q (US$bn at annual rate) Exports of goods & services (+$bn) Trade-weighted value of US$ March 97 = 9 7 9 9 - - - - Residential construction (-$bn) - Jun- Dec- Jun-7 Dec-7 Jun- Sources: Thomson Financial; US Bureau of Economic Analysis; ANZ.
European and Japanese economies will be adversely affected by 7 stronger currencies and (in Europe) tighter financial conditions Euro area Japan Composition of real GDP growth Composition of real GDP growth - % pt contrbn to change in real GDP from Real GDP Domestic demand Net exports - - % pt contrbn to change in real GDP from Real GDP Net exports Domestic demand 7 7 Trade-weighted value of euro Trade-weighted value of yen Index Up ~% since late Index Up ~9% since mid-7 9 7 7 7 Sources: EuroStat; ECB; Japan Economic & Social Research Institute; Bank of Japan.
Although higher oil and food prices are pushing up headline inflation, core inflation remains little changed in G7 countries United States Consumer prices Euro area % change from "Headline" % change from "Headline" Ex-food & energy 7 Ex-food & energy 7 Japan United Kingdom % change from "Headline" % change from "Headline" - - Ex-food & energy 7 Ex-food & energy 7 Sources: US Bureau of Labor Statistics; Eurostat; OECD.
Inflation is rising sharply across Asia partly though far from entirely driven by higher food prices 9 Asian economies consumer prices China Korea Thailand Philippines % change from % change from % change from % change from - Exc. food & oil - Exc. food Exc. food 7 7 7 7 India Indonesia Malaysia Vietnam 7 % change from % change from 'Core' % change from % change from 7 7 7-7 Sources: national statistical agencies; ANZ.
Inflation is also rising across other parts of the developing or emerging world Selected other developing economies consumer prices Brazil Turkey South Africa % change from 7 % change from 7 - % change from 7 Chile Saudi Arabia Russia - % change from 7 - - % change from 7 % change from 7 Sources: national statistical agencies; ANZ.
Growth is also slowing in the developing world, although growth rates there will still be strong by historical standards Major developing economies real GDP growth China Other East Asia South Africa % change from % change from % change from 7 9 7 9 7 9 India Brazil Russia % change from % change from % change from 7 9-7 9 7 9 Sources: national statistical agencies; ANZ.
Resources commodity prices are unlikely to rise much further but will remain elevated by historical standards Resource commodity prices Coal US$/tonne Coking Steaming 7 9 7 7 Zinc US /pound 7 9 9 7 Gold US$/oz 7 9 US$/tonne Iron ore US /pound Aluminium US$/barrel Oil 7 7 7 7 9 7 9 7 9 Sources: Thomson Financial; ANZ.
Australia s national income is continuing to get a huge boost from rising commodity prices Australia s terms of trade (ratio of export to import prices) Real gross domestic income (GDI) and product (GDP) 7 - = % ch. from previous year Real GDI Real GDP 7-7 9-9 9 Sources: ABS; Budget Paper No., Statement ; ANZ Economics & Markets Research.
Australia is now starting to run trade surpluses for only the fourth time in two decades Exports and imports Trade balance $ bn $ bn Imports Trend Exports - - Actual - 9 9 9 99-9 9 9 99 Sources: ABS; ANZ
Up until very recently most of the income generated by the commodities boom has been spent Domestic demand vs supply % change from 7 Domestic final demand Domestic supply (GDP + net drawdown of inventories) - - 7 Sources: ABS; ANZ.
After nearly 7 years of continuous economic growth, Australia s economy has run into serious capacity constraints Indicators of spare capacity in the Australian economy Unemployment rate % of the labour force 9 7 9 9 Businesses reporting labour shortages % of businesses nominating 'suitable labour' as a constraint on output 9 9 Capacity utilization rate % 7 7 7 9 9 Office vacancy rates % 9 9 Sources: Australian Bureau of Statistics; nabcapital; Property Council of Australia.
Australia s underlying inflation rate is now at its highest level since inflation-targeting began 7 Consumer prices % change from 7 "Headline" "Underlying" Reserve Bank forecasts RBA target range No allowance for ETS start-up 9 9 9 9 9 9 97 9 99 7 9 Note: excludes impact of introduction of GST and major health policy changes. Sources: ABS; RBA.
The rise in inflation has been broadly-based, and not solely due to global forces or in resource-rich States Contributions to headline inflation, year to June quarter Headline inflation, resource boom cities vs others % pt contribution to change in CPI % ch. from previous year Other Brisbane, Perth & Darwin Deposit & loan facilities House purchase or rent Energy Food Other Energy "Nontradeable" "Tradeable" Sydney, Melbourne, Adelaide, Hobart & Canberra Food 7 Sources: ABS; ANZ.
The upward trend in inflationary expectations has been particularly alarming to the Reserve Bank 9 Household inflation expectations Business selling price expectations 7 % pa % pa Actual Trend Actual Trend 7 7 Sources: Westpac-Melbourne Institute; nab.
Australia is exposed to the global credit crunch because of our large external deficit and the way we finance it Current account deficits 7 Financing Australia s current account deficit US$ bn A$ bn - -qtr moving total US$79bn Current account deficit * member of euro area (deficit financed out of Germany's surplus) - - 7 US Spain* UK Australia Italy* Greece* Turkey France* Romania Portugal Sth Africa India Poland Ireland* NZ Methods of financing Net equity Banks' net borrowing Other net borrowing Other (incl. reserves) Sources: IMF; Australian Bureau of Statistics; ANZ.
Australian financial markets have come under the same pressures as their overseas counterparts 7 Banks short-term funding costs 9-day Libor spread over OIS (bp) US Australia Dec- Jun-7 Dec-7 Jun- Dec- Banks long-term funding costs -year swap spread (bp) Australia 7 US Dec- Jun-7 Dec-7 Jun- Dec- 9 Corporate bond yield spreads AA spread over -7 yr gov't bond yields (bp) Dec- Jun-7 Dec-7 Jun- Dec- Dec = Share prices US Australia US Australia 7 Dec- Jun-7 Dec-7 Jun- Dec- Note: all data shown as -day moving averages. Sources: Bloomberg; Datastream.
As a result, banks have raised lending rates by more than the increases in the Reserve Bank s official cash rate Australian interest rates % pa bp Standard variable mortgage rate bp bp Cash rate 9 9 9 9 9 9 97 9 99 7 Source: RBA.
The credit crunch plus the effect of higher interest rates on credit demand has led to a sharp slowdown in credit growth Credit provided to the Australian private sector Total credit Credit to households % change from % change from Housing 7 Other personal 7 Credit by source Credit to business - - % change from By financial intermediaries Securitized credit % change from 7 7 Source: Reserve Bank of Australia.
Tighter financial conditions and global uncertainty have contributed to sharp falls in confidence Consumer confidence Business confidence Ratio of optimists to pessimists (%) Net balance of optimists minus pessimists (%) Actual 9 Trend - - Actual Trend 9 9 9 99-9 9 9 99 Sources: Roy Morgan Research; nab; ANZ
Hard data is also increasingly suggesting that the economy is slowing more quickly, perhaps, than expected Retail sales Housing finance commitments % change from Actual Trend - - % change from Actual Trend 7 7 Motor vehicle sales Residential building approvals - % change from Actual Trend - % change from Actual Trend - - 7 7 Sources: ABS; ANZ Economics & Markets Research.
Australia s housing market has clearly softened but is unlikely to become as dire as America s House prices Housing commencements - - - - % change from Australia US 7 7 7 99s average = Australia US 7 Population growth Mortgage delinquency rates*.... % change from Australia US % of total loans outstanding US Australia. 7 7 * 9 days or more past due. For Australia, securitized mortgages only. Sources: ABS; US Commerce Department; S&P; Mortgage Bankers Association of America.
The resource boom States appear to be slowing more markedly than the rest of Australia 7 Retail sales Employment % change from (trend) % change from (trend) Qld, WA & NT Rest of Australia 7 Qld, WA & NT Rest of Australia 7 Housing finance commitments Unemployment rate - - % change from (trend) Qld, WA & NT Rest of Australia 7 7 % (trend) Qld, WA & NT Rest of Australia 7 Sources: ABS; ANZ Economics & Markets Research.
Economic growth will be much slower in -9 than in recent years, and the unemployment rate will increase Spending and output Employment and unemployment 7 Real % change from Domestic final demand.... % change from Employment (left scale) % 7. - GDP (output)... Unemployment (right scale) - 7 9. 7 9 Sources: Australian Bureau of Statistics; ANZ.
The Reserve Bank has signalled that it will be cutting rates soon probably beginning next month 9.. 7. 7....... Short-term interest rates % pa 9-day bank bill yield RBA official cash rate 7 9 Yesterday s RBA Board meeting left the cash rate unchanged at 7¼%, but signalled that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing That probably means that they will cut the cash rate at next month s meeting This earlier-than-expected rate cut likely stems from two considerations the further increase in banks lending rates in July (when the RBA thought no further lift in official rates was needed) the marked slowing in the economy over the past couple of months (perhaps more than they wanted) There will likely be a second rate reduction before year-end (if only to ensure that lending rates do actually fall) Depending on the extent to which inflation begins to decline, rates will fall further during 9 Sources: Thomson Financial; ANZ.
The prospect of lower interest rates and signs that commodity prices have peaked imply that the A$ is now heading lower A$ and commodity prices A$ and interest rate spreads. US$ - =. US$ - =.9.9.9.9 A$ vs US$ (left scale)...7.7.... A$ vs US$ (left scale) RBA index of commodity prices in US$ (right scale) 7 9 7 7 7...7.7.... Spread between Australian & US 9-day interest rates (right scale) 7 9 - Sources: Datastream; Reserve Bank of Australia; ANZ.
After falling % from its peak the share market looks cheap but only if you are confident about the earnings outlook ASX All Ordinaries ASX trailing p/e ratio 7,,,,,,,, Dec 979 =,, Lowest since April 99, 7 7 Sources: ASX; Thomson Financial.
Earnings projections are more likely to be revised downwards over the next few months Pre-tax company profits (excludes financials) % change from (-qtr moving average) 9 7 % of GDP (-qtr moving average) - - - 9 9 9 9 Sources: ASX; Thomson Financial.
Summary The global credit crunch is continuing and won t end until the US housing market bottoms out, which seems unlikely any time soon The world economy is slowing the US hasn t experienced recession yet, but probably will during the next months some other advanced economies will also fall into recession in the developing world, by contrast, inflation is a bigger risk than recession Australia s economy is also slowing noticeably rapid developing-country growth benefits Australia via its impact on commodity prices but Australia is also exposed to the global credit crunch via our large current account deficit and the way in which it is financed the effect of that exposure has been magnified by the upward trend in Australian interest rates (and oil prices) over the past months The next movement in Australian interest rates will be down with the first rate cut now likely to come as early as next month The A$ has probably peaked against the US$ the US$ may take another leg downwards against major currencies later this year as a US recession becomes more evident but with Australian interest rates and commodity prices having peaked the A$ is now on a downward trend