By Michael Every of Rabobank
Breaking With Convention
Pity those having to make forecasts for the global economy right now. After all, they are having to do so less than 80 days from a US election in which two radically different policy platforms are being proposed to the American public, and so to every corner of world markets, yet with some worrying things in common.
The Republicans offer extending consumer and corporate tax cuts, the introduction of universal (and higher for China) tariffs, the deportation of millions who entered the US illegally, and the president having more say on what the Fed does. It may also include help for first-time home buyers, with Trump indicating he might steal a populist Harris policy after she stole ‘no tax on tips’ from him, along with removing the $7,500 tax credit from EV purchases. It’s hard to read that as anything other than an at best an inflationary (at first) boom or at worst a stagflationary bust, a further fiscal blow-out, and a massive change in the global trading and financial architecture.
The Democratic platform released at its Chicago National Convention -- where angry protesters were outside and at 11:30pm EST, President Biden still hadn’t started to speak(!)-- includes raising the corporate tax rate to 28%, not much new on tariffs, a pledge to provide amnesty to the millions who entered the US illegally or have been deported from it, and a promise the president won’t interfere with the Fed - though that doesn’t preclude appointing dovish personnel who back MMT. It also includes building 3 million new homes (by whom?) with $25,000 for first-time home buyers, and stopping “price gouging” in the food industry: on the latter, some, like Adam Smith, argue anti-Borkian anti-trust actions increase competition; but this takes years, while a quick political win looks like Diocletian’s diktat on prices, leading to reduced supply. It’s hard to read that as anything other than at best a lower-inflation, more state-guided growth, or at worst a different sort of stagflationary bust, also a further fiscal blow-out, and again implying massive, different, changes in the global trading and financial architecture.
Can you see how many structural breaks with convention are now appearing all at once? Possibly not, as for many it’s easier to retreat to “Rate cuts!”, and its conjoined twin, “Higher asset prices!”
We are already in a global easing cycle, and Jackson Hole late this week will provide further proof that the Fed will finally join. However, rate cuts to what end against a backdrop so challenging that politicians are up-ending so much political and economic convention?
To make my point with just one key example, the Bank of England (BoE) started their own rate-cut cycle on 1 August: and we already see ‘Interest rate cut fuels immediate upturn in UK property market’. Indeed, with the five-year fixed rate mortgage now around 4.80% vs. 5.82% in August 2023, UK property website Rightmove says potential buyers contacting agents since that 1 August cut have jumped 19% y-o-y, and it now expects a “buoyant autumn property market,” upgrading its house price forecasts from -1% for 2024 to +1%. If rates fall enough, could we eventually put a zero after that second figure?
Does anybody -- other than estate agents and those now selling their house-- think the answer to any of the recently-riot-struck, housing-crisis-inflamed UK’s socio-economic and socio-political woes is “even higher house prices?” The same runs true even where we thankfully haven’t seen the violent UK reaction being mirrored yet. Indeed, as I put it to someone the other day, project the housing dots forward, and try saying “feudalism” without saying “feud”.
Yet what will BoE interest rate cuts --with services inflation still entrenched(!)-- actually achieve other than that property market response?
Yes, it’s easier to borrow. But even with the new government push to build on green belt land, rational private property developers won’t build enough houses to compensate for the “Higher asset prices!” momentum flowing from “Rate cuts!” In which case, to make housing affordable, the debt-laden government might have to use the fiscal room lower rates give it – but that would imply a larger state role in the economy. For example, it could offer a subsidy to first-time buyers - directly from all taxpayers to richer home sellers in the Aussie experience, where prices rose to match the subsidy given; or it could build large numbers of new houses with the fiscal breathing room it gets, which might not be bad policy in some eyes, but is certainly unconventional in recent decades. Or there could be BoE macroprudential measures: if we had implemented such policies, with a guiding national geostrategy, years ago rather than just snorting “Rate cuts!”, we would not be in the mess we are now.
Combining several of the above, forward-planning Singapore just tightened loan-to-value ratios for mortgages for its large stock of (excellent) public housing to ensure that cheaper options than the expensive private sector remain available for most of its population. That’s a deliberate policy tightening with a socio-economic goal even as the rest of the world is about to undertake a monetary policy loosening that will inevitably flow back to the very open island economy.
That sits alongside something we have been saying for some time: that the more prudent course of central bank action is not to do what ‘conventional wisdom’ in self-serving markets says, i.e., to cut rates with abandon; it may be to reduce rates slowly, and to a higher low than we have become accustomed to. Or, if central banks do cut more, to put in place counterbalancing tightening policies in some sectors.
Even if central bankers act very conventionally --which those in property and financial markets will see as the ‘Right Move’-- many politicians are likely to adopt convention-breaking policies that may counterbalance: for example, how about higher house prices and higher property taxes to match?
As another case in point, today saw the RBA’s August minutes, where they left rates at 4.35%, with the clear message now that they are on hold for a long time, and a subtext that the Bank wishes it had raised rates six months ago,… and could be forced to do so again(?) After all, with deposit and mortgage rates both plunging regardless of what the RBA is doing --it’s a global market! Who knew?!-- we also saw comments that a few weeks ago, “Financial conditions appeared to be less restrictive than had previously been the case,” while “In light of these developments, members assessed that the risks of inflation not returning to target within a reasonable timeframe had increased.” Indeed, the earlier conditioning assumption was that RBA rates would start to fall in late 2024 and be trimmed several times over the subsequent year – something the Bank now sees would require a significantly tighter policy path to achieve. Yet the market is easing for it.
Because as far as local markets are concerned, the next RBA move is still down, not up, whenever that might be (“Rate cuts!”). There are no macroprudential measures to fear, and the government will provide another first-time buyer subsidy if anything were to accidentally go wrong again. As such, house prices can only ever go up, up, up (“Higher asset prices!”). All is for the best in the best of all possible worlds. Perhaps Australia is The Luckiest Country. But in the long run, everyone’s luck runs out. And a more unconventional future awaits when it does.
In China, the PBOC didn’t move its 1-year rate from 3.35% nor its 5-year rate from 3.85% today. However, the Chinese property market remains very out of luck, with the political tide there having taken a ‘Common’ turn rather than a merely unconventional one: its houses are for living in, not speculation. Can you imagine that mantra in the West? It would shatter convention!
