Investors preparing for August volatility

This week on Talking Finance:

• Eliza Owen, Head of Australian Research at CoreLogic Australia, runs through the latest house price figures for July;
• Kyle Rodda, Market Analyst at IG, shares his thoughts on what is behind the Australian dollar’s continuing surge;
• Stephen Smith, Partner at Deloitte Access Economics, tells me why private business investment is expected to fall by 15 per cent this year; and
• Michael Pachi, Political Editor at Nine Radio, takes me through the political fallout from stage 4 lockdowns in Melbourne.

[Music]

AG: Hello and welcome to Talking Finance, I’m Alex Gluyas and on this week’s show I’m discussing July’s house price figures which saw Melbourne and Sydney extend their lead as the hardest-hit cities, so to take us through that is Eliza Owen, who is the Head of Australian Research at CoreLogic.

Yesterday we also saw the RBA keep the cash rate at 0.25 per cent and announce it will resume buying government bonds today so I’m joined by Market Analyst at IG, Kyle Rodda, to discuss the market’s reaction to those comments and what is behind the Aussie dollar’s continued surge.

On the economy, we’ve got Partner at Deloitte Access Economics, Stephen Smith, who tells me about the economic impact of Melbourne entering Stage 4 restrictions and his recent Investment Monitor report which forecasts private business investment will fall by 15 per cent this year.

And finally, Michael Pachi, who is the Political Editor at Nine Radio, takes me through the political fallout from stage 4 lockdowns in Melbourne and how the aged care crisis is impacting Daniel Andrews’ relationship with Scott Morrison.

[Music]

AG: And now to take a look at the housing value numbers for July, here’s Head of Australian Research at CoreLogic, Eliza Owen. Well, Eliza, housing values experienced a third consecutive month of decline in July, with Melbourne and Sydney leading the decline. Could you explain why they continue to be the hardest hit cities?

EO: Yeah, Sydney and Melbourne are definitely the hardest hit so far in terms of property values. Since the onset of the pandemic, Melbourne property values are down about 3.5 per cent and Sydney’s down about 2 per cent. These capital city regions basically had the highest level of exposure to overseas migration before the onset of the pandemic. The fact that international borders are now closed has created a really big demand shock to those markets. The other aspects of demand that have been changed by COVID-19 for those cities are also demand that comes from international students and we know as well that the arts, hospitality and tourism sectors have been very affected by the nature of this downturn and the restrictions on social consumption and things like that.

That’s had a big impact particularly on the inner-city rental markets of theses cities. As Melbourne faces renewed lockdowns, then we would expect to see further price declines. There is also a cyclical element here as well. Sydney and Melbourne tend to have lower lows in their downswings and higher highs in their upswings. Even though these capital cities are hardest hit so far, they did also have the strongest growth rates, Sydney’s still about 12 per cent higher over the year and Melbourne’s about 8 per cent higher over the year.

AG: Then, on the other hand, we’ve got Canberra and Adelaide which were the only capital cities to post a rise in dwelling values in July, what do you put that down to?

EO: These markets are performing relatively well for slightly different reasons. Adelaide’s always been a slow and steady performer and it’s also always been more of an owner-occupier market. The fact that we’re seeing dwelling values up 0.1 per cent over the month I think is just a reflection of that kind of steadiness in the market and it hasn’t really seen the shock from the withdraw of investors that we’ve seen in some of our larger investor markets like Sydney and Melbourne.

The ACT’s really interesting. I think there’s a lot of job stability in higher paid jobs such as those in the government service, where there’s a lot of work required right now. I think that combined with record low interest rates and some incentives for first home buyers who might be young professionals looking to get into the market, that sort of helped to keep that market quite resilient. It’s interesting with the ACT, the fact that the cash rate has been cut to a record low, property prices are rising, that’s the dynamic we would usually expect. I think it’s just that the labour markets have been so affected in other capital cities that they’re seeing declines even amid this record low cash rate. Then we’ve got, I guess, the regional markets which are generally showing a bit more resilience compared to the capital cities.

AG: Which particular regional areas are you seeing hold up best and why?

EO: Yeah, the regional markets are very interesting. The combined regional markets across Australia were flat over the month compared to about a 1 per cent decline across the capital cities. Some of the regions that we’re still seeing have positive growth rates over the Q or over the 3 months rolling to July, for example, the Illawarra region and Newcastle, largely those kind of secondary cities that are close to the metropolitans but maybe offer a kind of nice lifestyle aspect or a sea change kind of environment. I think it’s important to note that there are aspects of this pandemic which long-term would provide a demand boost to regional markets. For example, the normalisation of remote work or lower levels of density and congestion being appealing in the wake of a pandemic. But it is also important to realise that these markets aren’t going to escape a downswing in the short-term. There’s still a lot of job loss and income loss which will eventually create a drag on those markets. It’s just that at the moment they’re lagging capital city performance and so they haven’t quite realised the full extent of those downturns yet.

AG: And you discussed earlier about the RBA, they yesterday announced they’re keeping the cash rate at 0.25 per cent, so how are you seeing low interest rates flowing into the housing market and how’s this accommodating the sector?

EO: It’s a really interesting dynamic. I think the first trend we’ve noticed in the finance space is that the initial shock of the pandemic meant that low interest rates didn’t cause people to run out and buy property, people held off buying property and really focused on minimising their housing costs. Through May the ABS finance data shows us this record decline in the securing of finance for the purchase of property, but there was a record rise of about 25 per cent in a single month for the value of loans that were refinanced externally.

That’s sort of the immediate impact that these record low cash rates have had, as we see that mortgage rates have declined significantly over the past few months particularly in fixed rates where banks are really looking to lock in their customers for the longer term. That, I think, will have an impact of encouraging some property purchases and it will mean that the declines in the housing market will be milder than they otherwise would have been if we hadn’t seen that enormous sort of reduction to the cash rate.

AG: Do you think there’s a fair way the housing market still has to fall towards the end of this year, given the easing of wage subsidies in September or are we over the worst of it?

EO: Look, good question. I think the extent of the downturn will really be related to the resurgence of COVID-19 in Australia and how that influences social distancing restrictions and the slowdown of economic activity. That’s something that we don’t really know. We don’t really know how that’s going to play out. But it’s fair to say that the more stringent conditions are on business activity, the more that’s having an impact on the labour market which ultimately at the moment is affecting purchasing capacity and housing market performance. I would say there’s probably a fair way to go with this housing market downturn and I would expect to see prices improving once the labour market starts to improve and once international borders reopen.

AG: Thanks very much, Eliza, great to talk to you.

EO: No worries at all.

[Music]

AG: And now on markets, here’s Market Analyst at IG, Kyle Rodda. Kyle, as expected, the RBA didn’t move the cash rate yesterday, but signalled the three-year bond yield has been higher than its target range recently. How have you seen the market respond to the RBA comments?

KR: I mean, we didn’t get too many surprises, as effectively you just alluded to. I mean, if there’s one almost criticism of the RBA over the last few years is that they’ve always taken the glass-half-full approach and taken this cautiously optimistic tone which, despite all the issues in the Australian economy at the moment, they did again yesterday. I suppose that kind of attitude rubs off into their policy and has continued to do so. We haven’t seen much of a change in policy from the RBA and since they implemented their emergency measures in March. What do we get out of the RBA? Probably not a great deal other than they’re clearly signalling their seriousness about keeping the yield curve control policy to the letter of the law.

Obviously, you can infer from that, they’re willing to soak up that extra supply of bonds going into the market that the Government has had to distribute to obviously fund all of these deficits. Overall, the RBA meeting was very little surprise to the market and almost to the frustration of market participants. Very little signalling of further policy support in the future which I think market participants are probably creating a little bit.

AG: We saw the three-year bond yield fall sharply after the RBA comments. Is it still necessary for the RBA to resume bond purchasing today, do you think?

KR: They probably will because if they don’t the markets will start to expect going forward when they do provide this signalling that they’ll be bluffing. But they’ll not need to purchase quite the same quantity of bonds as they would otherwise and I think that’s kind of really the trick to yield curve control as we’ve seen it play out in other parts of the world too, is that you see a policy maker more or less jaw-boning yields lower and rather having to go all guns blazing actually entering the market to buy the actual asset. You can do the hard work by effectively just, again, jaw-boning the market.

The RBA will have to run its purchases just to show that it’s good for its word, but really, the power of the yield curve control is in that forward guidance, so it was something I’m sure was a tactical thing that the RBA implemented yesterday knowing that that’s the outcome it was looking for.

AG: And just generally, markets seem to be pushing through the news of stage 4 lockdowns in Melbourne and worsening COVID news in the US?

KR: A little bit. I mean, I think if you look at stock markets more broadly at the moment, they’re grinding sideways. The US stock market’s a little bit of an exception because we have seen this outperformance in tech and obviously because I guess really this growth factor investing remains popular and I suppose policy is geared to that kind of thematic. We are continuing to see US stocks slowly push higher, if you look at the S&P 500 and obviously the Nasdaq, sitting at record highs. But if you look locally where we’re grinding sideways more or less and really, if you look at push and pull factors, that central bank put is still there, yield is still to be found in stocks and very few other places, so that’s keeping the bid under stocks in general.

But again, there’s a lot of uncertainty about the future. The virus concerns are continuing to play out in the market on a day to day basis both domestically and abroad and it means we’re in a bit of a holding pattern right now. Stocks are the only place to go and that’s keeping them well supported, but again, we’re entering what’s traditionally a very volatile month of August and it’s keeping stocks moving sideways and with very little indication at this stage a break out to the upside for risk assets is really on the cards.

AG: And the Aussie dollar continues to surge upwards. How much of that is attributed to the depreciation of the US dollar or what other factors are driving the Aussie dollar higher?

KR: Well, we’re seeing Aussie dollar outperformance and we have for a little while. It’s been very correlated with S&P 500 futures, for example, so you can global risk sentiment, the Aussie’s sort of just been lumped in that basket. I mean, against the US dollar if you look at it just toe to toe, the Aussie versus USD, there is a yield advantage for the Aussie now, particularly at the back end of a yield curve which has supported the Aussie dollar for the last three or four months.

But recently and ultimately, it has been greenback weakness that has driven currency markets more broadly and that’s a good news story. It’s come because the Euro’s stronger and that’s because the European politics looks a little bit more orderly. It’s come because the Fed has flushed the world with dollars and it’s come as more or less there is still the belief that the global economy is going to rebound and that will narrow economic outperformance between the US and the rest of the world.

The Aussie dollar’s been on an uptrend for a while, it remains in an uptrend. In the last couple of weeks, it’s been a greenback story and probably for the next few weeks, I think the Aussie dollar will be far more determined by the volatility in the dollar, especially as we start speculating about this fiscal package. Will they, won’t they, what will it look like in the United States? And obviously, ongoing concerns about the virus in the United States and broader global macro. It’s definitely more of a greenback story than an Aussie dollar story for the pair at the moment.

AG: Are you anticipating the Aussie dollar’s upward trend will be sustained for the rest of this year? What would it take for it to take a negative turn?

KR: To take a negative turn, probably a much more active RBA, which wouldn’t occur. We’d have to see a major deterioration in the global economic recovery. And while we have seen a little bit of a stalling in the recovery more or less, as has been revealed in the data recently, it’s not a reversal, it’s not another deterioration, we’re not looking at another wave of lockdowns, we’re not looking at another double-dip recession yet. If that were to emerge, that would be really the thing that would keep the Aussie dollar lower, particularly as that sort of proxy for risk.

But while I suppose risk appetite is stable, risk assets are trading sideways and everyone’s really just waiting for the next good piece of news to buy into risk in the future. The Aussie dollar probably has a bias to the upside and again, especially as the greenback looks at a period of cyclical weakness. An Aussie dollar that could push further into the mid-70s by the end of the year, that is, is not necessarily out of the equation.

AG: And just finally, back to markets – do you think there’s a possibility that we could see a crash again similar to what we saw in March or is this investor confidence about stimulus and the central bank’s proven willingness to assist through monetary policy, is that going to be enough to kind of maintain markets and at least keep them remaining flat for the rest of the year?

KR: I think that ultimately we’ll continue to see stocks move higher into the back-end of the year. However, I think that with volatility still relatively elevated by historical averages, that we will see another 5 to 10 per cent correction here or there, especially when sentiment shifts. I think, interestingly, a lot of market participants are actually probably preparing for at some stage of the month of August, that next 5 to 10 per cent move, which generally happens three or four times a year in a normal market environment anyway, is probably on the cards. August is a very volatile month, seasonal is peaking for a number of different factors.

Although, in the bigger picture, risk remains skewed to the upside for stocks, again because of that kind of TINA trade, that policy supported flow that’s going into equity markets. It’s very unusual for things to go on in the one direction, particularly in a market that’s a little bit overvalued at the moment and a little bit overbought. So another 5 to 10 per cent move, particularly considering some of the risk events that we’ve got coming up is more than likely and again, I think a lot of market participants are looking to the month of August as that potentially occurring.

Long-term, it’s still very positive, still very constructive, but there’ll be certainly turbulence with volatility still historically elevated.

AG: Good to talk to you, Kyle. Thanks for your time.

KR: Thanks for having me.

[Music]

AG: Now for a look at economics here is Stephen Smith, Partner at Deloitte Access Economics. Stephen, the big news in the past week has been the announcement of stage four restrictions in Melbourne. Daniel Andrews said around 250,000 workers would be stood down or sent home. How much worse do you think these new measures make Australia’s economic position?

SS: They certainly don’t help. The first few rounds of restrictions and up until stage three restrictions in Victoria were costing in the order of about a billion dollars a week. Now, with stage four we think that the cost has increased to in the order of about $3 billion a week so an extra couple of billion a week so that’s obviously a material hit to Victoria’s economy and Victoria being a quarter of the national economy. There’s some obvious impacts nationally as well. The other thing that is happening in Victoria which spills over is a lack of confidence in people wanting to spend, this general perception that we’re not out of the woods and we certainly weren’t out of the woods before this spike in Victoria but quite clearly that has dampened confidence across the economy more broadly and this is weighing on our ability to bounce back.

AG: There’s obviously been a whole range of restrictions put in place including food processors having to reduce staff members so what impact will these measures have on Australia’s supply chain given Victoria’s pivotal role in the national supply chain.

SS: I think it’s probably a little bit early to tell. I think it’s definitely the most important thing, is to think about the health crisis first and so absolutely there are economic effects from these stage four restrictions but it’s critical to get the health issue under control and that means curbing the spread of the virus so that we are able to then get in place a recovery and a plan to bounce back as quickly as possible. It’s certainly unfortunate, the spike in Victoria in the last several weeks after Australia did exceptionally well in dealing with the first wave, if you like. Dealing with the health crisis is critical. There will obviously be flow on impacts for things like supply chains but to the extent that they are concerned about the economy more broadly, well not really. Australia is a huge producer of food and other essential items so our concerns around the supply chain are probably not as grave and dealing with the health crisis is certainly the priority.

AG: You released your Investment Might report earlier this week which forecasts that private business investment is set to fall by 15 per cent in 2020. What do you put that down to?

SS: There is a couple of things. Firstly, it wouldn’t be right to say that private business investment in Australia was booming prior to COVID. We were in a position where investment was chugging along, mining investment had picked up again but private non-engineering and construction, that is the commercial construction sector, was reasonably flat and a lot of the non-mining engineering activity was in the transport space being funded by state governments so we had this debate in Australia for example on things like whether companies should be accepting lower rates of return and therefore investing without the expectation for the same sort of return. That wasn’t a great situation and that situation has been made much worse quite clearly from the shutdowns that have taken place on the back of COVID and now the fact that we have had this second wave in Victoria and ongoing issues around confidence and uncertainty.

Uncertainty is a killer for investment and the quicker that we can deal with the health crisis the better but we do think there will be a material fall in construction activity both because of the shutdown but also because of ongoing issues around confidence and uncertainty and frankly the situation in Victoria means that it’s quite difficult to see exactly when we might be on a better footing there but assuming that we are able to get control of the situation in Victoria quite quickly from there we’d be looking for the government to provide a better plan around economic reform which then provides the private sector with the basis to make investment decisions and be confident about the returns they can earn.

AG: When that recovery starts once the situation is controlled in Victoria are you anticipating a sharp bounce back in business and government investment and what role do you think that will play in stimulating the economy in the recovery?

SS: Government investment is critical so there is a large number of government infrastructure investment projects either underway or in planning. We estimate in the order of 555 projects worth in the order of 314 billion, that’s both underway and in the planning phase so certainly governments have the ability to bring some of that forward and to sure up the pipeline of projects under construction but we don’t expect a bounce back in private sector activity, investment in mining is chugging along reasonably well and that’s because the prices of major commodities have held up well during this period. The non-residential and non-engineering construction sector is offices, retail, health and education facilities. These are parts of the economy which have been hit very hard by COVID and we certainly don’t expect a quick bounce back in that sector.

AG: The report noted that government infrastructure spend was particularly crucial to stimulating the economy once Covid is contained, are you expecting approvals to be fast-tracked as a way of speeding up the economic recovery?

SS: Yeah, we do, certainly there has been some talk already of the approvals process being shortened which would be important so historically there has been approvals processes that can take in the order of 3.5 years. The plans around environmental approvals in particular but broader federal, state and territory cooperation to hasten that approval process to under two years. That’s no small task but I think that that certainly would be important particularly in bringing those government funded projects forward as much as possible.

AG: Over the next few months are we expecting to see an increase in investment projects being cancelled or delayed as less new projects are being announced, as businesses move to cut costs?

SS: We certainly haven’t seen that yet, I think despite Victoria I think there still is at the moment a degree of let’s wait and see, let’s not put a line through this particular project of that particular project at this point. I think there is generally a wait and see approach about exactly how long it will take to get on top of the health issue and then exactly what the economy will look like, what the structure of the economy will look like and what demand might look like post this immediate COVID period and so that’s where I think the focus will be rather than at this point cancelling projects. We have seen the value of projects in the investment monitor database did decrease in the last quarter but a large part of that was the completion of the national broadband network, now it’s substantially complete and other than that we still saw new projects coming into the database so overall no, I don’t think we’ll see a huge number of cancellations in the next couple of months but should this drag on longer beyond that that’s when we’ll start to see, I think, some companies having to pull the pin on plans.

AG: Thanks very much for your time, Stephen.

SS: Pleasure, thank you.

[Music]

[Parliament audio clip]

AG: For a look at what’s happening in politics here is Political Editor at Nine Radio, Michael Pachi. Michael, the big news of the week has been the COVID outbreak in Victoria and the decision to enter stage four lockdown. There has been plenty of commentary on Daniel Andrews, do you get the feeling he is losing support or people are backing him in?

MP: It is a bit hard to say. There is obviously a lot of people that aren’t happy with the sort of response that Victoria has had and the response that Daniel Andrews has given. I suppose that Daniel Andrews and the Victorian Government more broadly is trying to do what they can to deal with an unfolding crisis. I suppose a lot of it will come down to this inquiry about hotel quarantine, did these massive outbreaks of COVID-19 in Victoria really stem from there and if they did why wasn’t more done to try and stop it earlier on. Those sorts of issues, I think, are really going to dominate the reasons why Victoria’s cases are so high. Of course, the other issue for Victoria has been its contact tracing system. We have been regarded as being far too slow in terms of telling people whether or not they did have COVID-19 and potentially people not isolating if they did.

There is obviously mistakes that have been made on the Victorian side of things but at the same time, and we have heard this plenty of times before, Alex, this is unprecedented, we are in uncharted waters and while the rest of the country does seem to have handled it better than Victoria I’m not sure that all the blame can be levelled out at one state government.

AG: There has also been some tension between Daniel Andrews and Scott Morrison regarding the unfolding aged care crisis. Do you think this has the ability to fracture relations between the two?

MP: I think it did and I’d noticed that in the last week or so both Daniel Andrews and the Prime Minister are trying to patch things up. Of course, aged care is a responsibility for the federal government and there are questions from the Federal Government to answer as well. After what happened at Newmarch House in Sydney at that nursing home you would sort of think that the federal government would have started to implement programs across the country to make sure that every aged care facility across the country, whether they be a private facility or not, that they had procedures and protocols in place to ensure that if there was a similar COVID outbreak that it could be easily handled and to ensure that there was enough PPE, protective equipment and so forth.

The Federal Government is saying that it didn’t realise that the COVID would spread that quickly as it did in the Victorian nursing homes but obviously I do think that again what lessons were really learnt between what happened in Sydney a few months ago and what’s happened in Melbourne nursing homes in the last few weeks. Of course, you’ve got the State Government that needs to take some responsibility for allowing workers to still go into these nursing homes and spread the virus because a lot of it is being born by the workforce but I think the Federal Government also had to take some responsibility for probably not acting quick enough to make sure that there’s some sort of plan across the country especially after what happened at Newmarch House in Sydney.

I do think as a result of that when the blame game did start and did appear to be escalating especially towards the end of last week I do think that the Prime Minister and the Premier moved in to try and settle those tensions.

AG: Last week we also saw Gladys Berejiklian caught off-guard regarding Anastasia Palaszczuk’s decision to close the Queensland borders to Sydney siders, how are you viewing the relationship between State Premiers at the moment?

MP: Generally, I would say that the relationship between the State Premiers is okay. I don’t think that it’s completely fractured, I do think that the National Cabinet meeting that happens every fortnight is a very good idea for those Premiers and the Prime Minister to basically talk about the issues are in each individual jurisdiction. They also get briefings from officials, from health officials and so forth. I can understand there would be some anger especially between some states if there are decisions that they don’t inform each other about. I suppose to a certain extent we’ve also got to keep in mind that in Queensland we’re in an election cycle as well so a lot of the decisions that are probably being made are being made with the election in mind. As we know generally border closures do seem to be supported by the local populations, whether that being Queensland or Western Australia.

I know that in Queensland people like Anastasia Palaszczuk did come under a lot of pressure for not reopening the Queensland border but she was saying she’s sticking by that decision until she feels that states like New South Wales and Victoria and all of that have got their COVID cases down. Eventually, they did and she started reopening the borders but she’s quickly shut them back down again as the COVID cases move back up. Should she have probably told Gladys Berejiklian of her decision last week to close the border to New South Wales residents? Probably she should have but I think these sorts of issues while they do seem as though there is a tension there and I think that it would be fair for people to assume that there is a tension there, by the same token I also think that the state’s premiers and chief ministers also realised that they do need to work collectively to get things done especially during such a challenging time.

AG: Scott Morrison has continued to be vocal about China’s interference following the recent cyber attack so how do you think this commentary is impacting the relations between China and Australia?

MP: From what it would appear at a personal level obviously the relationship between Australia and China isn’t too good but at a business level it does appear to be doing a lot better you could argue. From what it would seem China is still buying our resource exports, latest figures show they potentially didn’t buy as much of our coal and iron ore but on the whole they still seem to be buying our resource exports even though there is this tension that does exist within the relationship. Of course, agricultural exports to China are down a bit especially when it comes to beef and barley but on the whole I think that it’s been straddled very carefully and I do think that the meeting that the Foreign Minister, Marise Payne and the defence minister Linda Reynolds had last week in the US was quite interesting in the sense that the US wants Australia to be even more aggressive against China but Australia is saying we’ll do things at our own pace, it’s not prepared to back America into an anti-China stance completely. It did seem to wind back some of the rhetoric at that meeting in Washington last week.

AG: That’s great, thank you very much for your time, Michael.

MP: No problems, good on you, Alex.

[Music]

AG: And this week we celebrate the birthday of legendary musician, Louis Armstrong, who was born on the 4th of August back in 1901. Here's a little of What A Wonderful World to remember him by... and bring a little joy to these sobering times we all find ourselves in.

[Music]

AG: That's all from me, have a great week!

[Music]