HALMARICK To understand this issue we have to assess current financial conditions – which have significantly contracted globally. We will see how the market trades today, however it is notable that the ECB [European Central Bank] raised rates last week, and Commonwealth Bank of Australia (CBA) expects the Federal Reserve to raise rates by 25 basis points on the morning of 23 March, our time.

There is a general expectation that the action over the weekend in Switzerland will control contagion quickly. But there is no doubt that the fallout of Credit Suisse and SVB is a big event and market volatility indicates it will be one of the factors the RBA [Reserve Bank of Australia] assesses in its next rates decision.

ONG These are still early days and there is a lot happening. It comes down to whether the risk transmits through to the real economy, globally and in Australia. If we see a tightening in financial conditions, a reduction in lending, increased cost of banking, increased regulation and greater scrutiny these will pass through to the real economy.

There is a great deal of uncertainty at the moment. Even if everything settles down, there will almost certainly be some additional, global costs to the banking system that will transmit to Australia with impacts on the real economy.

Global central banks are very mindful of this. But it is a difficult situation, given underlying inflation dynamics are still there and they are elevated. Perhaps inflation will be put aside at the moment with a shift of focus to financial stability. Such are the challenges of financial stability versus ongoing inflation risks.

Our view – which the ECB demonstrated last week – is that central bankers now have a much larger policy toolkit including different tools to deal with different challenges. On the financial stability side, they have balance sheet and liquidity tools. On inflation challenges, it is more to do with interest rates.

Overall, we agree that the Fed is likely to continue to lift rates. But the bigger question, I think, is about financial stability and transmission through to the real economy. This could mean global terminal rates are a little lower or even open the door for cuts if current events develop more traction.

YETSENGA The most immediate question is the extent to which developments in the last week have changed the economic landscape and what we might therefore expect to see in the coming year. I think they have changed it a lot.

NEWNAHA The way the US has implemented HQLA [high-­quality liquid assets], the LCR [liquidity coverage ratio], and the NSFR [net stable funding ratio] has been different from Australia. Australian banks are well capitalised and much more stable than what we see in the US. The deposit base is largely retail, Australian bank balance sheets are actively hedged and APRA [the Australian Prudential Regulation Authority] enforces strict adherence to LCR and NSFR requirements.

What we have seen in the US does not necessarily translate to Australia. On the other hand, I suspect the US banking system is at a crossroads right now, and the implications are likely bearish for ongoing global credit creation.

EVANS The RBA has pointed out that Australian wage growth has been more benign than in the US. The US ECI [employment cost index] peaked at 5 per cent while Australia’s is currently 3.3 per cent and likely to go higher.

One of the key factors is labour market participation. Australia has had a sharp rise in participation, while there has been a fall in the US. Australia expects a bigger impact on labour markets from migration – net migration peaked at 400,000 in 2022 and we expect 350,000 new arrivals in 2023. The supply side of the Australian labour market is more encouraging than it is in the US. Even so, US ECI growth is starting to slow.

One thing we do not follow as closely as we should is Australian unit labour cost. The big fall Australia has had in productivity and GDP output per hour means unit labour cost growth is running at 7 per cent. This is the effective cost to companies of employing workers and it determines how much they need to raise their prices by. I believe this sits as an outlier concern in comparison with our fairly benign wages story.

YETSENGA Most of the difference between Australia and the US this cycle is well understood, and what most observers are talking about in future policy action is not dissimilar.

It does appear that the Australian labour market has some structural challenges and these are giving us different outcomes to the US. The Australian government has announced policy changes to try to address these, and we have to assume there will be more.

HALMARICK Before I answer I will say that migration alleviating some of the stresses in the labour market is a positive development. We are back to population growth being where it was pre-COVID-19, which is good news all around.

We were already forecasting house prices to rise through 2024, mainly because we expect interest rate cuts to start before the end of this financial year. This view looks better today than it did a week or two ago!

Lower interest rates and more net migration through 2024 is likely to mean upward movement in house prices. I do not think it will translate to generalised inflation, though, as the overall economy will be weaker. We can already see consumer spending slowing down and we believe it will get softer still as the lag effect of higher interest rates comes through.

ONG The increase in net migration was rapid over the course of 2022, particularly in the temporary cohort. China reopening quickly adds to this, and we are now seeing population growth return to pre-COVID-19 levels. There has also been a lift in permanent migration numbers. This is additive to demand with a potential upside to inflation.

The clearest near-term pressure point is on rents, which are already rising – particularly in Melbourne and Sydney, with the rapid return of international students. Rent growth is currently running at about 4 per cent annually but this number will climb substantially higher. We can already see some of the additional pressures and general demand that will occur as population growth strengthens.

Eventually, we are likely to reach a shortfall in housing. As the RBA has said, the policies that address housing supply are not monetary policy – there is only so much monetary policy can do to influence these issues.

NEWNAHA This time last year, we were talking about how much house prices would fall. At the time, we were saying around 15 per cent – which is roughly where we are now. The situation is developing, but it appears markets are pricing for potential rate cuts in the US – and if this happens they will also push for cuts in Australia.

This is what we mean when we say there is a risk the SVB fallout could have far-reaching consequences. Our current forecast is that RBA rate cuts will emerge in Q1 of 2024. If this happens sooner it will put more pressure on the housing market. I suspect house prices are close to bottoming; with strong migration, house prices and possibly inflationary pressures will remain elevated going forward.

EVANS It is quite a scary outlook. We have talked about more demand coming from migration – and it will come. We know that house prices fall when interest rates rise and vice versa. What happens in the middle period is that many people start to feel they can afford a mortgage and thus start buying houses. But history shows the economy is typically very weak in this period. We expect the Australian economy to be extraordinarily weak in the second half of 2023 and the first half of 2024.

The demand side will be supportive of housing, certainly by 2024. But the supply side remains a problem. Another recent development is how many contractors and builders are not around anymore. People who want to start building, adding to supply, are finding it much more difficult to find support from the overall economy.

There is a contraction of housing supply and a boom in demand. I suspect real shortages will show up in the house price story in 2024-25. More significantly, there is always general pain for the economy when we experience these big mismatches between demand and supply of housing.

YETSENGA Another aspect is that, I would argue, the signals we get about people’s long-term decisions are inconsistent with inflation returning to target. We have inflation that is more than double the target band on virtually any measure we look at. Meanwhile, the primary long duration decision in the household sector is housing. On a normal historical calibration, the auction clearance rate in Sydney last the weekend was equivalent to house prices rising by 10 per cent. I do not think this will play out, but it highlights the decisions households are making.

For businesses, the long duration indicator is capex – and capex expectations have held up very well. They have actually strengthened, according to the ABS [Australian Bureau of Statistics] measure. If we understand these data points, and with inflation being more than double the target band, we would have to see some really dramatic, quick changes if we are expecting RBA rate cuts by the end of the year.

ONG For markets that are starting to price in RBA cuts from later in the year, domestic considerations are not the main influence. Inflation is elevated but the challenge of inflation is globally driven – this is where the risks lie.

YETSENGA Central banks are all facing the same issue, though. One of the largest European banks found a resolution over the weekend – but the ECB still hiked last week. The US has 4,000 banks, so we have to ask whether it can regulate its financial system to the degree that other economies do.

We know credit is tightening: 40 per cent of US banks in the Fed’s last senior loan officer survey were tightening standards and more than 50 per cent of consumers say credit is much harder to get than it was a year ago.

The question we keep being asked about recent developments is whether this is a financial crisis. As far as I can tell, it is not evolving into one – it isn’t behaving in that way. But we should not shy away from the fact that the world has changed dramatically in the last 10 days, specifically in the sense that monetary policy is biting.

NEWNAHA Travelling in Asia last week, clients kept asking me if this is another global financial crisis. Our response is that it is not, but the pain could last longer. Essentially, what happened in 2008 was a credit crisis that morphed into a financial crisis, which resulted in central banks and governments enacting a group of policy prescriptions. The current situation is the reverse: a funding crisis with the risk of becoming a credit crisis.

Things have been moving at warp speed, and it feels like liquidity and solvency risks have become indistinguishable. The implication is that if depositors are not honoured, owners’ equity could go to zero. This has developed over the last 10 days or so.

The efforts we have had from the Fed and the liquidity swap lines that have been implemented may stem panic in the near term. But the reality is a lot of US banks are sitting on loans and mortgages that are trading well below par. The risk is that regulators and rating agencies lean on these banks, telling them to de-risk or issue more capital. If this happens, I believe share prices will head lower.

Going a step further, de-risking brings a lot of pain too. Even banks with assets of less than US$250 billion have tentacles that spread far and wide: they are responsible for roughly 45 per cent of all consumer lending, around 50 per cent of all commercial and industrial lending, around 60 per cent of residential mortgage lending and 80 per cent of commercial real estate lending.

If there is any pullback of credit provision from the banks, which seems likely, I think we will have a credit crunch on our hands down the track. This is not something the RBA will be able to avoid – and it places the risks of cuts on the horizon.

HALMARICK There is currently a clear lack of supply of new dwellings, which has added pressure on rents and on the cost of mortgages in the near term. But stronger population growth over the medium term has proven to be very beneficial to Australia, and that will be the case this time as well. History has shown that rising population is an important part of Australia’s economic growth. Population is one of the ‘three P’s’, alongside participation and productivity.

Wages growth in Australia has been lower than in the US, which is one of the reasons our cash rate is going to peak in the high threes rather than the fives.

EVANS We had zero net migration in 2020 and 2021. Despite this, housing prices boomed. Many other factors underpin house prices other than migration.

HALMARICK CBA [Commonwealth Bank of Australia] forecasts 1.5 per cent economic growth in Australia this year – a significant slowdown from last year’s 3.7 per cent, though 2024 will improve. As I said earlier, the rebound is due to our expectation of rate cuts starting before the end of this year.

Monetary policy is tight at the moment and we believe we will be hit by the lagging impact of rate hikes through the course of the year. Financial conditions have now tightened further because of problems in the global banking system. We are projecting a weaker economy in 2023 but a stronger 2024, indicative of a shallow U or V type projection.

ONG Our expectation is for Australia to experience weaker growth in 2023 – about 1.2-1.25 per cent – before a modest recovery to about 1.75 per cent in 2024. The real key is the composition of growth. We expect a much weaker consumer over the course of this year, particularly in the second half. This is a little weaker than the CBA profile.

We expect the RBA to hike once more, in April or May, but I don’t believe this is the main consideration for markets – it is what happens beyond that. We have a couple of cuts in our profile for next year. But, clearly, the discussion about what happens globally and the importation of tighter financial conditions from offshore is significant for Australia, even if the system here is strong. This is where the risks lie.

NEWNAHA I agree that the offshore outlook plays a significant role for the RBA. Our call has been 5.5-5.75 on the Fed funds rate, to be reached around July. There are obviously big risks to this call, given the developments that have played out over the last few days. With the US cash rate at 4.75 per cent, our forecast implies another 100 basis points of hikes. It will be a tough ask to get there. Our forecast was that US rate cuts would begin in Q1 2024. The risk now is that cuts are brought forward.

Taking all these factors into account, the risk is to the downside for our RBA cash rate call. Last year, we were quite vocal on our hawkish outlook for the RBA. Our current cash rate call is 4.35 per cent, which means getting 4.1 per cent by May and then another 25 basis points higher at the August meeting.

I think we can pretty much kiss that forecast goodbye, given recent developments. The RBA has already said we are close but not at the point where we can pause rate hikes, which suggests there will be one more hike. When that may happen is uncertain.

The most important question is what the Fed will do: will it hike at all from here, or will it pull back on QT? These are the issues we are thinking about at the moment. Australian real growth is currently below trend, but I don’t think this will have a significant bearing on the RBA’s outlook. It is more about offshore.

EVANS Prashant talked about the key transmission mechanism in the US: the smaller banks that avoided regulation, following the lobbying in 2018, will have to become more regulated. This will affect the availability of credit.

What this means is the profile we have had for the Fed has to be flattened, because growth headwinds will be greater for the US in the second half of 2023. We expect the Fed to raise by 25 basis points this week and we don’t expect further hikes after that – but we also do not predict rate cuts.

Su-Lin mentioned that central banks now have a lot of vehicles to deal with credit issues. But the Fed’s inflation objective will not be achieved in the second half of 2023.

There is a lot of talk about 2018, when the share market sold off by 20 per cent and the Fed made immediate cuts. But it did not have an inflation challenge. Even in 1997, the Russian crisis, it was a similar story – the Fed cut but didn’t have an inflation problem. I expect rates will hold up this year, in other words.

By the end of this year and into next, weakening economies will make enough progress on inflation that cuts will start in the first half of 2024. When this happens, I expect the Fed to be more aggressive than the RBA. This will be positive for the Australian dollar.

YETSENGA I agree that rate cuts are at the end of the policy queue, especially because the view of policymakers is that these recent events in the banking sector are largely idiosyncratic.

What we have to ask, in this context, is when risks go from being considered idiosyncratic to general. Central banks still have an inflation challenge, which I agree has pushed the hurdle for rate cuts quite high. Policymakers are focusing on the right things.

Even so, Australia must take notice of the regulatory response in the US as it implies that the rate structure should be flattened and that terminal rates are not as high as we might have thought.

In Australia, I believe most of the monetary tightening we have experienced since the pandemic is structural rather than cyclical. Almost every factor that drove the low inflation environment in Australia pre-pandemic has gone, so we do not have any rate cuts in Australia’s profile until the very back end of 2024. For this reason we believe 2024 will be weaker economically than 2023.

HALMARICK There is always scope for the economy to adapt. It was interesting to hear the treasurer speaking last week about the Productivity Commission report. He discussed many recommendations, some of which have been around for a long time, including measuring productivity better using data. For example, there is a government project that shows how technology has improved productivity, but the improvement is not reflected in the numbers.

There is also a lot of scope to use technology and education to align the workforce with the skills of the future. For instance, the transition or greening of the economy will be an important source of productivity opportunity. It is a post-pandemic world with a great opportunity to increase productivity. But we must get the policy agenda moving.

YETSENGA I don’t think there is any doubt that it has to be inflationary. Views on global inflation need to be adjusted on a structural basis. One of the consultancies suggests the climate transition alone will cost A$1 trillion (US$666.2 billion) a month, globally. This is not all additional but it includes doing a lot of new things and stopping a lot of old ones – transferring resources, money and effort to doing something new.

ONG This adds to the broader discussion about structurally larger fiscal positions, because there will clearly be an element of government expenditure in the decarbonisation process.

Budgets are under structural pressure from several factors, including demographics, defence, geopolitics and transition. We must account for the fact that budgetary positions may err to the looser side than would be desirable at some stages of the economic cycle – it is a structural uplift.

EVANS The picture is clear on certain commodities. If we are to achieve 83 per cent renewable energy by 2030, we need 10,000 kilometres of additional transmission lines. We are not the only ones around the world that will use this technology – there will be huge demand effects from rebalancing the investment profile, from which commodities will be big beneficiaries. n

NEWNAHA There has been years of underinvestment in the energy space – we are playing catch-up with the developments that need to be put in place. I think we can all agree that the cost of going green will increase.

YETSENGA I do not know if we will get wholesale repair because of the pressures in place. There is no doubt that they need to reallocate. In my opinion, what continues to fall out of this discussion is the idea that there is a sustained sequence of rate cuts on the back of this tightening cycle.

We have a labour market at generational levels of strength. We have a climate transition that is resource intensive for the public and the private sector – and is inflationary. We have a household sector that, just regarding its liquid assets, is in the best aggregate position it has been in about 15 years. The way the household sector has managed the rate hike cycle also suggests the allocation of debt is better than it was 15 years ago.

Meanwhile, we have inflation at more than double the central bank target and interest rates not far above the top of the target band. Accordingly, rate cuts are likely a long way out, at least in the sense of a meaningful series of easing. n

EVANS I believe central banks will respond to very weak growth, rising unemployment and a fair degree of success in bringing down inflation by the first half of next year. I suspect the RBA still thinks it will be at 4.75 per cent – but I think this is conservative, and that rates will come down to about 4 per cent.

I believe inflation will come down to around 4 per cent from nearly 8 per cent; the economy will be growing at 1 per cent with the unemployment rate heading toward 5 per cent. There is a case to provide monetary stimulus or, while policy remains restrictive, to be less so.

I do not think these conditions will be met until the first half, perhaps the first quarter, of next year. Expecting them to be met any earlier, either here or in the US, is going to prove to be the wrong way to go.

Moving forward, the low point in the next cycle will clearly be well above the previous low points. If we believe the neutral cash rate is about 2.75-3 per cent, something below 2.75 per cent is a reasonable low point that will need to be achieved over the course of two years.

YETSENGA It does not appear to have a negative effect on productivity; if anything, it may enhance it. Regarding the office sector, it seems that one of the drivers of high house prices is the fall in the average number of people per dwelling. This is roughly equivalent to the loss of nearly 200,000 dwellings in Australia, or 1-2 years of housing construction. I believe the shift in work patterns has added to stresses in the housing sector via excess demand, and introduced insufficient demand to the commercial property sector.

ONG Considering the possible implications for participation, if there is a permanent shift to working from home and a different work-life balance – which encourages the participation of labour cohorts that would not normally participate without this medium-term flexibility – it could be a factor that structurally uplifts participation.

EVANS There is a disconnect between what has been happening with cap rates for commercial property and what is happening to the market price of REITs. The market price of REITs is more liquid and currently reflects more pessimism about commercial property than we see on actual cap rates.

There will be a lag, in other words – but I think we are already seeing it play out in the second tier of commercial property, which is suffering. We will see a big adjustment in commercial property overall.

I am not sure what will happen with working from home in the longer term. I chaired a panel six months ago on which a chief executive – a pretty tough guy – said: “My view on it is that some people want a job and some people want a career.”

NEWNAHA I believe working from home should increase productivity. But it will probably be negative for the office sector. The sphere of influence of US banks is, as we have already discussed, also widespread. Offices could come under a significant amount of pressure in the US, which I suspect could have a knock-on impact globally.