There seems little doubt that the markets are turning ugly – unless you like fixed interest investments, that is. The world’s biggest stock index, the S&P 500 in the US, is down 22% from its highs and at its lowest since Jan 2021, when pandemic fears were at their highest. The 10 year bond rate in the US has soared to 3.15% and is headed higher.
Australia’s S&P 200, the main index for the local stock market, is also falling back. Its recent rises look more like a temporary phenomenon. It is now down over 6% in the last six months:
Australia’s market is less vulnerable that America’s, especially as the major stocks pay much better dividends, which puts a floor under stock prices. But there are indications that interest rates will rise here, especially as in the US some pundits are even talking of a 3-4% rise in official interest rates. Australia is likely to be swept along to some extent, and to push rates higher.
That will inevitably affect house prices, as even the big banks are acknowledging:
“Housing prices in Australia are expected to drop by 15% over the next 18 months - with prices in Sydney and Melbourne pegged to fall by 18%, according to economists from Commonwealth Bank.
“Head of Australian economics at CBA Gareth Aird predicted an 11 per cent fall in Sydney house prices this year, followed by a further 7 per cent drop next year.
Melbourne would experience a 10 per cent drop over the rest of the year and another 8 per cent decline in 2023, the CBA analysis found.
“Hobart’s hot property market was also expected to take a hit with a drop of 4 per cent in house prices this year and 9 per cent next year, with Canberra also expected to be impacted by the same declines.”
CBA is forecasting the official interest rate will rise as high as 2.1% by the end of this year, up from its current 0.85%. The CBA's forecast has changed dramatically from the 3% drop in housing prices they previously predicted for 2022.
Ever quick with a grasp of the obvious, Aird notes that “the extent to which prices contract will depend in large part on the speed and magnitude at which the RBA lifts the cash rate." Not likely to be wrong on that one.
There are also some dire signs in Japan. In many ways, what has been happening to Western economies: soaring debt, bubbles, low interest rates to keep the game going, was a process started by Japan in the 1990s when their property bubble collapsed.
So what is happening in Japan is what may will be coming soon in Western economies. It looks a little like a device for debt forgiveness. In the end, when debt is out of control some way of getting rid of the debt and starting again is the only option. It can be partially achieved with inflation, which erodes the real value of the debt. But what Quantitative Easing really represents is a kind of debt forgiveness.
Maybe Japan is a glimpse into the future:
“The more global inflation picks up, the more the BoJ prints. But the more easing accelerates, the higher the need to press hard on the brake when the (inflation) cliff approaches and the more dangerous it becomes.
“As a result, we will soon enter a phase where dramatic and unpredictable non-linearities in Japanese financial markets would kick in, according to the DB strategist, who also notes that "if it becomes obvious to the market that the clearing level of JGB yields is above the BoJ's 25 basis point target, what is the incentive to hold bonds any more?"
This leave us with a few exploding questions:
- Is the BoJ willing to absorb the entirety of the Japanese government bond stock?
- Where is the fair value of the yen on this scenario and what happens if the BoJ changes its mind?
- The BoJ may want to generate inflation, but how does it get there with triggering a complete systemic collapse?
“Finally, what happens if and when the yen careens off the fiat cliff, and domestic holders of yen-denominated savings flee into either dollars or cryptos? We will find out very soon.”
The global economy, it seems, is heading into difficult times.
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