another reason the RBA may not lift rates for a long time

It appears the BBSW spread is growing, and this may result in banks needing to lift rates.

Bank funding costs spark rate hike fears

BBSW has been super stable since @ 2011... so this is a bit of a surprise . It may be an anomaly, but it isn't and it actually stays this way, we will likely see see this flow through to a higher cost of funds for Australia's banks in the next couple of months , so we could be looking at 30bpts increases.

Thats more than 1 x RBA increase. So just like the APRA regulations have done all the work a cash rate increase would normally do, these sorts of things only add to that work and more it even less likely the RBA will be rushing to increase the cash rate anytime soon.

This actually represents a risk... it may tip a few P&I borrowers over... this whole transition to P&I that we are 2 years into is quite delicate. Its why the RBA hasnt l;ifted a finger on rates . They would have to be at least a little bit nervous about the potential impact of an extra 30bpts coming along at this very delicate time...

Im still calling a 20-30% chance of RBA reductions next year...

 

When does the royal commission end ?? .
Once that is all done and dusted they might be inclined to quickly raise interest rates.

 

The next rate rise is coming ... but maybe not from the Reserve Bank

 

Abit scary!

 

Oh I dunno... you're probably looking at reasonably modest increases to the cost of funds... but no one really knows. But yes, increases to cost of funds , which would lead to increases in resi mortgage rates , when combined with the fast approaching vast volumes of IO to P&I resetting coming in 2019 and 2020 does represent a potential problem....

Its why

A - I think its almost certain the RBA wont need to move the cash rate anytime soon. The APRA increases and the APRA/ASIC servicing calc and HEM changes have done a huge amount of the work that cash rates used to be used for, and any additional increases might turn a soft landing into a hard correction .

B - I think there's still a 30% chance of cash rate reductions because the name of the game will have to be "protect mortgage delinquencies from blowing out" throughout 2019 and 2020 in particular

Just another reason why expectations of east coast growth are probably unrealistic, why cash flow will increasingly become king, and why cheaper markets ( such as regionals or Adelaide or Perth) will probably actually become more attractive starting next year. They are the only markets where debt to income ratios allow ( mathematically at least) for any sort of decent growth...

 

So why is it BBSW and not BBSR?

 

Bank Bill Swap Rate history

The AAP Reuters page BBSW used to be the old 90day bill rate setting page before all the banks rigged the ship out of it. BBSW has been well cemented in markets based on its old page long before there was a interweb. Rueters screen used 4 alpha codes back then.

BBSW is a market rate for interbank rate setting. Most commercial lending and rate decisions are based on BBSW since bank bill futures and other hybrids can be set using official rate mechanisms. eg A borrower may pay BBSW + 2.5% + fees

A wider spread at a low rate may be just as much "profit potential" than a higher rate and Banks should be called on this bullship before it gets exploited. When rates were 10% a 1% profit margin had a value of $1,000 / $100,000. At 5% a 1% spread is worth exactly the same. Banks havent trimmed their margin. If anything they have exploited it and made billions in super profit by lying that they are holding rates. Crap. As rates fell the held margins so they made more profit v's cost of funds. Now they want to widen it again as rates rise ?? No better example than credit cards - Cause thet is transparent. So they want card rates to rise for same reason ?

Few banks can borrow at BBSW for retail funding and its minor for a source of funds. Short term stuff.. That why banks havent used official rates as a base for loan rates for many many years now. And why rates can move independently of official cash rates and market rates.

One of the biggest threats to interest rates is banks losing AAA ratings as the market cools, economy tanks, property falls (?), jobs are affected and funding challenges emerge as rates rise. Rates would spread far more than official rates and see banks putting up rates by 50pts v's official rates moving 20pts...Quarter on quarter it could add a load to those with investments and heavy debt and see a risk weighted rise in investor loan rates. Official rates will be useless to protect people at risk

Paul used to work for a major bank treasury.

 

Tend to agree that it'll be longer than markets expect (although they are starting to pane out further now too). Its partly a reflection of the additional power of rate rises in an economy where household debt figures are higher than historical averages (more potent and should technically have a larger impact).

I think they'll let good figures roll in, be sustained, before making moves. Essentially be very cautious. Similar to US, they've had good numbers for a while before pulling the trigger and are still doing it reasonably measured and slowly compared to the past. Its probably a little more cautious than predicting where indicators may be in 6-12 months time before pulling the trigger (monetary policy has a lag effect and usually flows through to broader economy a while after implemented).

History also tells us there's scope for an unknown spanner or two to de-rail lagged rate rise plans too (trader war, forced deleveraging, population slowdown, government policy changes, etc etc).

 

I called this several years back.... I said the RBA would face this conundrum eventually.

Which is why I'm calling a 30% chance or a pre-emptive RBA cash rate reduction in 2019 - to remove the risks the P&I reset poses to Australia's 1.6 Trillion of RMBS, which in turn removes the risk to Australian banks credit ratings, which in turn stops cost of funds blowing out and making the problem even worse as P&I and rates rises ( non RBA ) arrive simultaneously ....

Once that happens, delinquencies accelerate. cost of funds blows out even further and RBA cuts become ineffective as the increases to banks cost of funds exceed or match the RBA's remaining arsenal of 150bpts.

Now there's no way of saying at this point that this is a certainty to happen; accelerating levels of mortgage delinquencies, I mean. Thats why Im calling a 30% chance, not a 70,80 or 90% chance.... The only thing we know for certain already is that the risk of growing mortgage delinquencies happening has been elevated by the introduction of IO quotas, because it forces mass migration of investor and owner occupier IO to P&I in 2019 and 2020....

My guess is the RBA will be watching mortgage delinquency rates like hawks... and if they see any evidence its starting to show up in the data, they will make a pre-emptive RBA strike ( reduction) to ward off any acceleration. Cos that's Australia's credit crisis in the making right there if it is allowed to get off the leash...

But I doubt APRA will abandon the IO quota. The volume of IO lending still represents a massive systemic risk and needs to be fixed. That rebalancing of IO v P&I is just as important as keeping delinquency rates low.

So arguably the only way they can keep the IO quota in place and control the delinquency rate to ensure cost of funds stays as low as possible ( if it starts creeping up following mass P&I migration) may be a reduction to the cash rate ....

 

I give it a 44% chance!

 

well that's a decent chance as well

 

This is why I am not keen on fixing. I can't see rates rising anytime soon as the banks have already done a rate rise instead of the RBA. Property is slowing as the serviceability tightens, and it would tighten even more. So the next move may be down rather than up. Recent fixed rates seem to imply the banks may be thinking the same.

 

If this is implemented good luck to everyone!

Homebuyers' borrowing capacity could be cut by up to 40 per cent

 

Yep... called the focus on debt to income ratio's last year. I referenced comments from APRA's chairman at the time. He specifically referred to the fact he was uncomfortable with DIR's being higher than 6 x income, as that's about where nations such as the UK, US and Ireland were at when they suffered catastrophic corrections post GFC.

The article calls them Loan to Income Ratios. Same thing. I'm not sure we will see them fall as low as the article indicates, but it doesn't really matter; I mean, whether they end up sitting at @ 6x income as APRA's chairman has indicated he would prefer, or at the much lower levels indicated in the article; they are going to be way below the 15-20 x income possible pre APRA. And in fact, they're going to be lower than the already significantly reduced DIR's we see today, which generally hover around 7 or 8 x income.

Difficult to see how any sane person could expect future property cycles to replicate past property cycles under those circumstances.

Just look at the table in the article,. which indicates income of 500K would be required to qualify for @ 2.5 Million in lending, which seems to be generally accepted here as the amount of unencumbered property required for a 100K passive income. Its just not going to be within reach of the overwhelming majority. Those with 200K of income would be stopped just shy of 800K. That wouldnt even get them into a median Sydney or Melbourne home. And median household incomes arent 200K , let me tell you.

Yet even this week the usual suspects have been rubbishing the cash cow/debt reduction solution that I have demonstrated can achieve 100K passive income over 20 years even with zero growth.

I do look forward to hearing their "analysis" if this is implemented....

#itsnotrocketscience.

#blindfreddy

#cashcowskilldebt

 

I personally think that any talk of the RBA lowering interest rates is optimistic. People with savings are already getting way below the RBA's cash rate.

However, with the AUD dollar dropping, and I expect that to continue, I can see bank rates increasing as the cost of off shore funding increases.

The trade war/ negotiations could place a spanner in the works but I am not sure how. Lower petroleum prices seem a possibility though which could be good for some industry and consumer spending in a recovery.

 

Yeah, look all of that is true. But you have to appreciate that Australia..... its small businesses, its stock exchange, its superannuation funds, its retirees, its resi mortgage market, its commercial mortgage market...literally the whole nation - is reliant on the banks. And the banks are completely reliant on securitisation.

Right now Australian RMBS is considered GOLD. Spin rates ( delinquncy rates) are typically less than 2% . Non banks are even lower ( funny how most brokers thought non banks were riskier after the GFC - what dodos' they were proven to be) But US RMBS was GOLD too....... until delinquencies accelerated... I give you Exhibit A. GFC and credit crisis.

So protecting that will trump (no pun intended) everything else in the end, and thats why cash rate reductions have to be considered a realistic possibility if the spin rate starts increasing..

All the other economic rational is likely to irrelevant under those circumstances.

I'm not saying these things will happen. I'm just pointing out what is at stake IF they do.

I'm not quite sure Australians, or even members of this forum who are supposedly sophisticated, or even most brokers, have any comprehension of how securitisation works and how big the Australian mortgage exposure is. Its a little bit like a good driver who doesnt have a clue how the engine runs... they think they know cars, until the engine fails....

This is why I wouldnt discount RBA action if the spin rates start jumping...

30% chance. @Terry_w says 44%. 2019 should tell the tale.

 

I completely understand. I'm sceptical that if defaults really gather steam, and sentiment turns (look at NYC and Toronto markets at the moment; REIT is warning things are beginning to slow in Tas) that lowering rates will make any difference at this point.

The RBA need a two percent official drop to make an impact in that kind of market. Buyers do not have as much money to spend and increasingly the youngish (under 45) are becoming debt adverse.

 

For a real estate market to continue, where banks are tightening lending and I expect looking closely at those heading towards retirement, you need those young buyers.

 

You're talking about new buyers. I'm talking about stopping existing debts from defaulting.

Imagine that @50% of all loans are IO and they have 5 year IO terms . And imagine they are all going to re-set to P&I at, say 4.2%.

200K loan @ 4.2% 5 years IO.
Monthly repayments jump from $700 (8400 pa) to $1078 (12936 pa) 54% increase

300K loan @ 4.2% 5 years IO.
Monthly repayments jump from $1050 (12,600 pa) to $1617 ( 19404) 54% increase

and so it goes...

Now imagine if the RBA reduced the cash rate by 100 bpts and the P&I rate became 3.2%

Monthly repayments for the 200K loan would reduce from $1078 to $969. Still a big jump from $700 per month, but the jump is @ 38.4%instead of 54%

Monthly repayments for the 300K loan would reduce from $1617 to $1454. Again, 38.4% increase

Not suggesting these things will save everyone who cant afford P&I , but it may save plenty... and keep delinquency rates low enough so that cost of funds doesnt shoot up by 150 or 200 bpts and we end up with everyone paying 6% + P&I , which would almost guarantee a blow out in delinquencies... and would also almost certainly undo the value of portfolios of those who are doing the right things ....

 

The RBA is in a no win situation. If they reduce rates in the face of a growing number of defaults they jeopardize the AAA rating. Lose the AAA and banks funding costs go up irrespective of what the RBA cash rate is.

To be honest, I can't see how the AAA can survive the next 12 months.