We are in the middle of an unprecedented economic crisis. The purpose of this post is to unpack some of the potential economic consequences to Australia and its flow through to the broader housing market. The social distancing & travel restrictions currently in place will hit the real economy. At this current time, the health authorities have communicated a 'dial up’ of restrictions on social mobility that will increase over time and likely put Australia into one of its biggest ever recessions. Business sector: Many businesses will be required to shut down temporarily OR won’t have any customers due to the strict social distancing guidance put in place. This will lead to an enormous loss of revenue for individual businesses & on aggregate. Many businesses, without large support, will not be able to absorb changes of this magnitude and will go under (without massive support). We are only at the beginning of this over coming months more and more businesses will be impacted significantly. It’s quite possible that many businesses who trade goods & services will have massive % revenue drops. Household sector: Unemployment may rise quickly in the short term. Households will struggle to pay their mortgages. Payments will stop from employers who are struggling with cash flow and this will in turn lead to significant levels of mortgage stress. This will require massive support to make ends meet. The longer the measures go on, the larger the support required. Government sector: There will be a very large role for governments to play in coming months to manage the economic fallout. In a crisis like this, it is largely up to the government to save the day and limit the short-term impacts of this crisis as much as possible. Traditional notions of ‘debt & deficit’, the ‘role of government in the market’, etc will all to go out the window. The economic mantra is ‘spend, spend, spend’ in a crisis scenario like this. The economic crisis cannot be solved by trying to increase aggregate demand in the short term like most other crisis responses. This will not work at the same time as asking Australian’s to stay indoors. This weakens monetary policies effectiveness in boosting demand during the health crisis. Nonetheless, measures to support aggregate demand should help boost recovery efforts when we’re on the other side of this. Responses will largely be about backstopping those that are hurt (almost everyone) & ensuring the starting point on the other side of Covid 19 is as robust as possible & that the speed of the recovery is strong. Australia is better placed to handle this than most with strong institutions & a fiscal position that allows for a strong crisis response. Projected cost: So far the government has committed about 1-1.5% of GDP outside the automatic stabilisers in built in the budget. I believe the number will be at least 3 times this to get Australia through this crisis (likely a lot more). This should come out over coming months too. Monetary stimulus will also play a role. Unfortunately, the ability to use monetary policy may be a bit more limited given the transmission mechanism is through to aggregate demand (which is highly inelastic during a health crisis) & current rate settings already. The housing market The impact on the housing market from all this change is unclear at this stage. It’s unlikely the housing market will sail through this unhurt. Housing will perform better than most asset classes through this crisis, but ideas that people will run to property and prices will continue to rise are unlikely to bear true. The fiscal & monetary stimulus will assist in cushioning the blow. One obvious factor is that housing activity will dramatically fall in coming months. This will likely have some impact on prices & credit demand. On the plus side, housing assets are not very liquid. This illiquidity will likely help absorb a lot of the shock to asset prices. I.e. supply of housing will dramatically fall as home-owners refuse to sell, or have no means of trading property. This lack of trade may mean price falls, on aggregate, are limited to a much smaller bandwidth than other asset classes. Given the short-term nature of this shock, the broader impacts on the housing market will be tied to the level of unemployment created, and what happens in credit markets. Both these metrics will determine whether the impact on housing is short-term and minimal, or whether there'll be a large double digit & prolonged impact on the housing market. If unemployment rises substantially the housing market is likely in for some serious pain. Employment is sticky, so it takes some time to soak up and doesn't happen quickly. Sydney and Melbourne are likely overvalued if unemployment rises dramatically in these cities and doesn’t come back down quickly. Likewise, if credit markets squeeze and central banks can’t provide enough liquidity to solve this, then the housing market is likely in for some pain as mortgage stress appears on the back of rising funding costs. To date, there has been some stress in RMBS markets, which suggests there may be funding costs rises for banks shortly. The RBA & central banks will likely intervene here to ensure that borrower rates do not increase at a time where they need to fall. We are heading into an economic tsunami like many of us have never seen before. The stress Covid19 will put on the economy, employment & the government will be enormous. There is much unknown and unclear at this stage, but it will require very large fiscal/monetary responses to help cushion the blow. How employment, credit markets & businesses look on the other side of this crisis, will largely determine the size of the impact on the housing market.