Consumer sentiment; Housing finance
- Lending to build new homes slumped in January. Loans to build homes fell by 9.4 per cent in January to their lowest level in two years. Loans for the purchase of newly erected dwelling slumped by 13.5 per cent – marking the biggest monthly fall in seven years.
- Overall, the value of housing loans fell by 5.3 per cent in January. The number of loans to owner occupiers down by 4.6 per cent, while investment loans fell by 6.8 per cent.
- The proportion of first home buyers in the market fell from 15.8 per cent to 15.2 per cent of all lending in December – the lowest reading in 6½ years. The size of the average home loan compared with a year ago has fallen for the first time in nine years.
- The Westpac/Melbourne Institute index of consumer confidence eased in the latest month. The index fell by 2.3per cent to a nine-month low of 104.1 in March. Aussie consumers believe that bank deposits are the wisest place for savings (27.1 per cent of respondents), followed by paying debt (22.6 per cent).
What does it all mean?
- Whichever way you look at it, the latest housing finance data clearly highlights just how soft conditions are in the housing sector. Buyers seem to be holding off on purchases in all areas. Loans for the construction of new dwellings – a key forward looking indicator for activity housing activity – fell by almost 10 per cent in just one month and are now holding at the lowest levels since December 2008. While loans to purchase newly established dwellings have recorded the biggest fall in seven years, sliding by over 23 per cent in the space of just two months.
- It’s clear that the double whammy November rate hike is certainly having a profound impact on the housing sector. And the likelihood of further rate hikes and the substantial growth in house prices since the global financial crisis are making potential home buyers rework their sums. And it is not only are owner occupied loans that are falling, with even investor finance on the slide. The slump in investment loans is yet another sign that potential property investors believe that property prices are in for a period of consolidation, and as such can afford to take their time on investment decisions.
- Interestingly the size of the average home loan compared with a year ago, has fallen for the first time in nine years. No doubt the higher home loan interest rates have resulted in potential home buyers only being able to afford less as such it is hardly a surprise that property prices have eased over the last couple of months. Higher interest rates have also resulted in the proportion of loans taken up by first home buyers falling to the lowest levels in 6½ years. The weakness in dwelling activity will no doubt result in more subdued economic growth in the near term
- The latest fall in consumer confidence highlights the cautious attitude displayed by Aussie consumers. The uncertainty about future rates and rising petrol prices.
- Interestingly the latest survey includes respondent’s views on the safest place to park additional funds. And over the past three months consumer’s views have certainly shifted. The safest place for savings still remains the bank, while paying down debt recorded a modest gain. Interestingly the major gainer was investing in shares, which recorded its best reading in 1½ years.
- The talk of further rate hikes has no doubt altered consumer perceptions. Consumers are more likely to use saving, to cut their debt levels or put it in the bank rather than use it for any other purpose. There was even a fall in the gauge of whether it was a good time to buy a home or a car. If the conservatism continues, retailers will have to continue discounting in coming months to generate interest.
- Looking forward retailers will still need to discount in the near term but it is likely that the worst is behind – especially for some of the Queensland retailers. The other good news is that it is looking more likely that the Reserve Bank Board will be sitting on its hands until mid 2011. Interest rates are already modestly restrictive and there are good grounds to argue that the last move to a tighter monetary policy was a little premature. The Reserve Bank would be best served by allowing confidence and spending to repair. The strength in the labour market is also a positive and likely to drive spending in the midterm.
What do the figures show?
Housing Finance
- The number of new owner-occupier housing loans fell by 4.5 per cent to 48,871 new commitments. The number of loans is 2.2 per cent lower than a year ago.
- Loans for the construction of homes slumped by 9.4 per cent in January to 4,561 – marking the lowest reading in two years. Loans for the purchase of established dwellings (ex refinancing) fell by 1.3 per cent, while loans for the purchase of newly erected dwelling slumped by 13.5 per cent – marking the biggest monthly fall in seven years. The slide follows a 10.2 per cent fall in December. Refinancing commitments were lower by 6.3 per cent.
- The value of new housing commitments (owner occupier and investment) fell by 5.3 per cent in January. Owneroccupier loans slumped by 4.6 per cent while investment loans fell by 6.8 per cent.
- Banks accounted for 89.3 per cent of all loans taken out in January up from 89.3 in December.
- The proportion of first home buyers in the market fell from 15.8 per cent to 15.2 per cent of all lending in December – the lowest reading in 6½ years and well below the record high of 28.5 per cent set in May 2009. Fixed rate loans accounted for 8.2 per cent of all loans, down from 8.9 per cent of loans in December. And the average home loan across Australia stood at $283,700, down 0.2 per cent on a year ago.
Consumer sentiment
- The Westpac/Melbourne Institute index of consumer sentiment fell by 2.3 per cent in March to 104.1 after rising by 1.9 per cent in January. The latest reading marks the weakest reading in 9 months. The index is now down 11.3 per cent on a year ago.
- The current conditions index fell by 3.6 per cent, while the expectations index fell by 1.5 per cent.
- Four of the five components of the index fell in March:
- The estimate of family finances compared with a year ago fell by 1.6 per cent;
- The estimate of family finances over the next year fell by 6.8 per cent;
- Economic conditions over the next 12 months was higher by 5.7 per cent;
- The measure of economic conditions over the next five years fell by 2.9 per cent;
- The measure on whether it was a good time to buy a major household item fell by 4.8 per cent.
- There was a fall in the gauge of whether it was a good time to buy a home (down 3.2 per cent to 114.5). There
was a more modest fall in the gauge of whether it was a good time to buy a car (down 2.7 per cent to 132.4). - Aussie consumers believe that bank deposits are the wisest place for savings (27.1 per cent of respondents), followed by paying debt (22.6 per cent), real estate (16.3 per cent), and shares (12.2 per cent).
What is the importance of the economic data?
- Housing Finance data is produced monthly by the Bureau of Statistics and shows commitments by lenders, such as banks, to provide finance for housing purposes. The lending figures relate to those looking to buy or build homes to live in as well as those seeking to buy or build homes for investment purposes. Generally people get their finance organised first, so the figures are regarded as a leading indicator on the housing market.
- Westpac and the Melbourne Institute release the Index of Consumer Sentiment each month. According to Melbourne Institute: “The survey of consumer sentiment was first undertaken in 1973 and was conducted on a quarterly basis until 1976, a six-weekly basis from 1976 to 1986, and has been conducted monthly ever since.” Confident consumers may be more inclined to spend, especially on major items.
What are the implications for interest rates and investors?
- The rate hikes over the past year are having a profound impact on consumer spending patterns. The housing sector is cooling while businesses continue to highlight weak trading conditions. CommSec expects the next rate hike to take place in May however there are clearly an array of risks to our call. And if activity levels remain subdued over the next couple of months it is possible the anticipated May rate hike could be pushed out by a month or two.
- Looking forward, it is clear that Aussie consumers are holding on to their conservative attitudes and any further talk of rate hikes will be detrimental to modest improvements in levels. Interest rates need to remain on hold for an extended period to tempt consumer to part with their cash.
- Retail discounting will continue to be a theme in coming months to generate consumer buying interest. However the outlook for retailers is likely to modestly improve as the massive rebuilding phase in Queensland will boost spending across an array of sectors.
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So the Australian fund manager has agreed to buy USD and sell AUD at 0.9379 in 3 months time.
At the forward date the transaction unwinds itself. The profit/loss of the transaction is shown in the table. For simplicity, we have used a USD amount of $1,000,000 at the end of the forward contract.
The calculation is simple. At the end of the forward contract the fund manager is selling USD 1m at the forward rate to get AUD (1,000,000/0.9379) = AUD $1,066,118.
If the fund manager doesn’t have USD1m to sell at the end of the contract because there have been no sales from a portfolio, then they also have to buy USD at spot. If we use 0.6500 as the spot price, this would cost $1,000,000/0.6500 = AUD $1,538,461. That is, it costs $A 472,343 net to settle the contract. When the AUD goes from 0.9500 to 0.6500 in a three month period, then the currency forwards lose AUD $472,343 for every $1m hedged. This was the situation in 2008.
The table below shows the cash flows associated with unwinding the forward contract above (0.9379) at different T90 spot rates.
To repeat, in this example, which mimics the market in the 3rd quarter of 2008, a fund manager with a portfolio of fully hedged USD assets would have had to find almost half a million dollars in cash to settle every million dollars hedged through a currency forward. A fund manager with a $1 billion portfolio would have had to pay out close to $500 million in cash to settle the contract.
Of course not all fund managers had fully hedged portfolios or 3 month forward contracts. Many had longer dated forwards or some of their portfolios unhedged.
Effect on Portfolio
There are several potential effects on a portfolio, depending on how it is structured:
When there is a cash loss from currency forwards, there is also a matching upward valuation in the assets. The value of the fund does not change. The difficulty is that the portfolio value is paper profit and the payment of cash is a real payment.
Assets may have to be sold to settle the forward contract. In a ‘hybrid’ portfolio that has both liquid and illiquid assets, this might alter the proportions of each. The fund might become overweight in illiquid assets. Most funds have limits around the proportions of each.
The cash that needs to be paid may use up the existing liquidity in the fund, including the normal cash buffer that is used for redemptions and any accumulated income.
The forward loss may be accounted for as a trading loss. Income flowing into the fund will be set against the loss and not paid out as distributions.
The fund, if it is able, may have to borrow to fund the cash settlement. Income coming into the fund would then go to paying off the loan.
Where there has been the extraordinary circumstances of both market illiquidity in property and fixed interest, coupled with the enormous fall in the Australian dollar, it is not surprising that there have been some funds that have had to alter the redemption schedule or distribution practice due, at least in part, to the effects of the negative cash flow on the currency forward contract.
The Performance Effect
You have seen from the example above the possible scale of the effect of extreme currency movements. Of course not all funds are fully hedged. International equity funds or those funds that are perceived more liquid behaved differently to the cases we have discussed above:
International equity funds are liquid. If cash is needed the manager simply has to sell assets.
International equity funds can range from fully hedged to fully unhedged. Typically, most would not hedge more than 50%. There are both passive currency managers and active currency managers. The focus for international equity funds is not just the cash flow effect in very volatile markets – it is the currency effect throughout all market cycles. An appendix has been attached to the back of the paper highlighting the different approaches adopted by ‘International Equity’ managers on the Lonsec approved list.
In summary, it is important to be aware of the effects of currency movements along with asset sector movements. Even skilled equity fund managers find predicting the direction and size of exchange rate moves difficult, therefore using currency as a source of alpha can be fraught with danger. In many cases the currency effects swamp the underlying market effects and, as we have seen, can also lead to changes in redemption and distribution policies for some Funds.
Analyst: Fawaz Rashid
Date Released: November 2010
Authorised by: Paul Pavlidis
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