It's Beginning to Look Too Much Like Christmas

In the last couple of weeks, I have dined in crowded, upmarket restaurants in Sydney and Melbourne. I looked around at the patrons in both restaurants and they were mostly older, and I don’t think they had big mortgages. 

But that wasn’t the case in the scramble for goods on Black Friday and probably on Boxing Day. The statistics show that Australians have been running down their savings because their income is not matching their higher cost of living and rapidly-accelerating home mortgage costs. In the new year a great many more will embrace a second job.

Banks have been watching this trend with some apprehension because the December rate of consumer spending locks in further interest rate rises. That means those with big mortgages (negotiated on the back of interest rate assurances from the Reserve Bank) are going to slash their expenditure, particularly as they have now run down their savings.

So, the world of 2023 is going to see Australia display more standard of living differences than we have seen for many years.

Those enterprises serving the mortgage belt are going to have a rough time. The supermarkets will try to adapt by standardising products with house brands and other mechanisms, but others won’t have that flexibility. The coming interim report season will shine a light on those enterprises that can prosper in these circumstances and those that are going to struggle. And, as I will explain below, some banks will be among those under pressure.

One of the features of next year’s reporting season will be the sharp deterioration in business confidence in the Albanese government. In the gas sector, while all the publicity focuses on the temporary price cap, the real threat is the fact that the government wants to take control of pricing, production and marketing in the gas industry if the industry doesn’t do what the government wants. That is going to cause a major fall in gas investment which will cause a shortage of gas, probably starting next year.

On the power front, at this stage batteries and pumped hydro are too expensive so gas must be used as a backup especially as the government has taken nuclear off the table. The world is shocked that Australia is looking to go down the route of rule unpredictability. A capital strike in gas and oil is being proposed and if it gains momentum it will have a severe impact on the Australian nation.

At the same time, the government’s industrial relations legislation is going to make managing labour much harder. Both these developments will curb investment.

On the other hand, the world needs our coal, gas, iron ore and other minerals and the likely growth rates in these areas will at least partly offset downturns in the mortgage belt when the Australian nation’s economy is totalled in GDP figures.

Speculation on whether Australia is going to have a recession or not requires evaluating the downturn areas against the growth areas. Australia could avoid a recession but still experience a widespread downturn as a result of spending cuts in the mortgage belt.

One of the aspects of the current labour climate is that, in many areas of the community, the labour shortages mean that enterprises, including government enterprises, no longer control their work force. Private and government enterprises are being told by their workers that they only want to spend a certain amount of time in the office each week. And with the shortage of labour and, in particular, skilled labour, companies currently have no choice but to be flexible with their staff.

This is very dangerous for large enterprises because they are no longer passing the skills on to the next generation and most CEOs can see the danger. At this stage, companies are hoping that the current situation will be temporary and workers will increase their time in the office. But a large number of workers are equally as determined that this should not happen and, if the work force wins, then larger enterprises will not need the office space they currently lease.

We will see dramatic surpluses in all major capitals and there will be a scramble to develop new uses for empty buildings which will impact values, particularly in offices of lesser quality.

In the US, the downturn has proceeded further than Australia and so Federal Reserve measures are beginning to moderate inflation which is impacting interest rates and wonderful for commodities like gold.

But inflation has been incorporated into the US wages system and once that happens the only way to reverse the process is to keep pressure on the economy via higher interest rates and a squeeze on liquidity. And that is exactly what the US is doing. It is not an easy juggling act and if you go too hard the downturn is severe — if you go too soft, inflation breaks out again.

Like Australia, those who are affected by the squeeze will cut back their expenditure and the subsequent downturn hopefully stops price and wage rises.

But there is one group of Australians who are actually starting to smile – those with money in the bank. In recent years, banks have been able to borrow offshore at lower rates than Australian borrowings. As a result, they have kept their profits high by pulverising depositors who for the most part kept their money in the bank.

Now, overseas borrowing is more expensive than local raisings, so we are starting to see deposit rates increase. That is likely to develop momentum in coming months unless there's a sharp downturn in overseas interest rates.

But an alert. Some banks are offering higher term deposit rates for one-year deposits then they offer for two years. Those banks clearly expect interest rates to fall next year. That’s good for the share market.

At the same time, people on mortgages are desperate to contain the cost and so there is extensive mortgage swapping. Banks will be forced to cut their margins to retain their customer base. If the trends, we are now seeing are maintained or increase then bank profits from housing are going to be under a cloud as margins are squeezed.

On top of that, there will be more bad debts, but history tells us that people with mortgages do everything possible to maintain their payments. In Australia a lot more people will take on second jobs to maintain bank mortgage payments.

Nevertheless, home lending, which has been the powerhouse of bank profits in recent years, looks set to be a tougher arena later in 2023 because the number of new loans will fall and holding into your customer base will be paramount. Banks will need to do well in other areas.