MORGAN STANLEY: The housing boom is ending

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Morgan Stanley has released a bombshell 41-page note on Australian macro conditions which highlights the risks to the nation’s housing market – and by extension the economy and RBA interest rates – in the year ahead.

The paper, co-authored by Daniel Blake, Antony Conte and Stephen Ye in Sydney along with the colleague Chris Nicol in Melbourne, says:

Housing activity has peaked, and we believe the macroprudential induced cooling off period will take growth momentum lower, lift recession risks, and amplify the need for easier fiscal policy.

That “anchors our bottom-of-consensus macro forecasts for Australia,” the authors say.

Key to the outlook is that while the housing construction market delivered the boost to growth that the RBA was looking for the rate cuts in early 2015 after the Abbott government’s “miscalibrated 2014 Budget,” drove investment borrower demand and prices to a level where Australia’s banking regulator, APRA has, “been forced to tighten macroprudential policy, despite the likely cost to growth.”

That’s important Morgan Stanley says because a tightening cycle has begun:

Despite common belief that lower for longer RBA rates will see strong housing conditions persist, we think macroprudential is effectively tightening policy settings. Alongside the 10% speed limit on investor property lending, higher mortgage risk weights and a sharp ~100bp repricing on the front book of investor mortgages, we have noted a material tightening of lending standards since mid-2015. Fundamentals are also deteriorating, with slower net migration taking our underlying demand estimate down by ~30k to 155kpa. We are now calling the peak in the housing cycle, and expect further falls in auction clearance rates and house price momentum, with a negative impact on construction occurring over 2016.

All of that means that the risk of recession in Australia is rising the authors say given the “housing slowdown comes at an awkward time, with a -1.6ppt drag on GDP from resources capex continuing through 2016, overwhelming the contribution from the lower AUD and services exports (about +0.5ppt).” That means Morgan Stanley has a bottom of consensus growth forecast of 1.9% for GDP and 0.7% for domestic demand in 2016.

That means that fiscal and monetary stimulus are needed, the bank says. While they await signs on the fiscal front from new prime minister Malcolm Turnbull, treasurer Scott Morrison and others, the authors believe there will be “another 50bp of rate cuts” in the first half of 2016.

But even though housing “over-delivered” and is now the target of APRA’s attention, Morgan Stanley says it does not expect a 2007 US-style housing crash. That’s because there are key differences between the two markets and environments they say.

  • Quality of mortgage structure – notwithstanding the fact that lending standards are weaker than required, they are far stronger than seen in the US through the mid-2000s. Also crucially, Australian mortgages are full-recourse to the borrower, with bankruptcy coming at a high social cost.
  • Conservative households – with a saving rate at 9%, prepayments across the mortgage book (over 2 years) and forbearance procedures allowing time to work out of delinquency.
  • Gearing overstated, given offset accounts – the rapid growth of offset accounts (a flexible mortgage prepayment that is available for redraw) has seen these balances rise to ~9% of household income, meaning effective household gearing is closer to 143%.
  • Limited bank capital and funding risks – the quantity and quality of bank capital has been rising, and APRA notes the majors stand in the top-quartile of peers with a APRA CET1 ratio of around 9%. Funding risks have also fallen markedly following the GFC, with deposit funding increasing from 40% in 2007 to 60% of liabilities now, and the RBA standing by as lender of last resort.
  • Monetary and fiscal policy scope – both the RBA and Treasury have degrees of freedom, with the RBA cash rate at 2.00%, budget deficit under 3% of GDP and net government debt at 14% of GDP.

That doesn’t mean that housing won’t still slow and the impacts of that won’t filter into the broader economy and impact growth, and cause unemployment to rise (Morgan Stanley’s forecast is 6.8%), it just means no housing crash as the RBA tries to repeat “the soft-landing of the 2003-04 housing boom.”

Which is why the bank believes rates need to fall.

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