Why Mortgage Rates are on the Rise
On Tuesday, the Reserve Bank of Australia distinguished itself for creating a record of 2 years of doing nothing.
Given the stagnant state of the Australian economy, if the Reserve Bank is going to be forced into action it's more likely that its next move will be to lower the official rate, just to counter the impact of higher global rates on an economy that's mortgaged to the hilt as events are moving through global money markets that will flow directly through to higher domestic rates
What’s driving the rate rises?
In September 2017, at one of her final outings as head of the world's biggest central bank, Janet Yellen announced that it was finally time to begin unwinding the great monetary stimulus that has propped up the global economy for much of the past decade.
While Wall Street largely chose to ignore the announcement the stimulus unwinding was an important development.
Since the financial crisis, the US Federal Reserve has pumped more than $US3.5 trillion into the US economy; a large portion of which washed around the globe via a process known as ‘Quantitative Easing’ or in simple terms: money printing!
When combined with official rate cuts down to zero in the U.S, it pushed market rates to their lowest levels in human history.
It was supposed to spur investment and employment but instead, helped inflate asset prices around the globe from real estate to share markets and beyond but, it appears no one had given much thought as to what may happen once the process is reversed!
As of October 2017, the U.S Federal Reserve began pulling $10 billion each month out of the system and on the surface the amount appears trivial against the Fed's total debt of $US4.5 trillion but, this process is having an impact, particularly on short-term market rates, which have moved higher since January 2018.
Removing cash from the system creates a relative shortage which, like any commodity, forces the price higher…and when it comes to cash, the price we're talking about is the rate.
But it's not the only factor lighting a fire under global rates!
Donald Trump's tax cuts have seen multinationals repatriating cash creating US dollar shortages in some markets and there is the escalating trade war between the US and China which is causing US dollars to rush for the safety of home.
On the domestic front, the Hayne Royal Commission has cast a cloud over the banks, exposing years of reckless management, excessive risk taking and lax lending standards.
What will this mean?
Loans will be more difficult to obtain in the future and potential borrowers are likely to find their bank either unwilling to lend as much as previously, if at all.
Higher rates offshore will ripple through our financial system because our banks have borrowed heavily in wholesale debt markets offshore and Royal Commission or not, they will have to lift mortgage rates if their wholesale funding costs rise.
Since the financial crisis the banks have worked hard to discard the notion that the Reserve Bank is the only body with the power to shift interest rates.
Remember those out-of-cycle hikes, the banks' refusal to pass on the full official rate cuts during the financial crisis and last year, when the banking regulator (APRA), the Australian Prudential Regulatory Authority clamped down on investor interest-only loans, the banks decision to restrict them by raising the price (interest rate).
While Reserve Bank governor Philip Lowe kept rates on hold, he noted the market squeeze driving US rates was already being felt here.
"There has been some tightening of conditions in US dollar short term money markets with US dollar short term interest rates increasing for reasons other than the increase in the federal funds rate," he said. "This has flowed through to higher short-term interest rates in a few other countries including Australia."
If we do see our banks pushing the button on a series of mortgage hikes in coming months, the RBA will have no option but to cut into its already record low of 1.5 per cent just to keep the economy on track…with inflation persistently below trend levels and very slow real wages growth, the Reserve Bank simply cannot afford for household spending to take a hit.
As a nation, we now have more than $1 trillion in net foreign debt, almost a tenfold increase since 1990 and the vast bulk of that is money (around $700 billion) our banks have borrowed offshore to help fund their lending businesses.
Between them, the big four banks hold about 80 per cent of all Australian mortgages and real estate has become their dominant business comprising up to 60 per cent of their total loan books.
If you are concerned about how these events may impact on your financial situation, speak to a knowledgeable finance professional to see what options are available to you in the current lending marketplace.