Finance & Fury Podcast

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Hi – hope you're all going well and welcome to Finance and Fury.

In this episode – look at cryptoasset investments and the increase in accessibility for retail investors through alternative structures – as in Western economies – US, EU, and Aus – these are becoming available for retail investors through structures like ETFs – i.e. exchange traded funds

1. This comes off the back of Treasurer Josh Frydenberg- looking at a series of regulatory and tax proposals covering digital wallets and crypto assets – focus being on reducing scams and fraud
2. The move could also include the introduction of an outline for central bank digital currency - which has been covered in depth already in previous episodes – may cover any actual announcement when there is more news about the actual policy
   1. In past episodes - Covered the BIS framework for what they consider cryptoassets – many have viewed this as legitimacy given to crypto – but it is legitimacy purely in the form of an asset – not a currency which was the original concept as a medium of exchange
   2. But these recent legislative developments seem to be an adoption from financial institutions to make money – and potentially a barrier to entry for anyone looking to get into supplying crypto – need for a DAO – decentralised autonomous organisation – another topic for another day – but institutions see money being made and want a piece of the action
   3. Late into last year - the Commonwealth Bank of Australia announced plans to support trading of 10 crypto assets on its app, which has 6.5 million active users.
   4. On top of this – there is a new megatrend – Crypto ETFs –

Before we get into that – I want to make one observation - Two ways cryptoassets have been treated by governments – it is based around those countries that adopt and those don't – and instead outright ban cryptoassets – this has been based around the power dynamic between politicians and companies, in particular banks and investment firms – in other words – who politicians are beholden to based around funding interests

1. Lets first look at countries where the politicians are not influenced by the lobbyists from major global banks – something like China – where the politicians are de-facto controllers of the economy have greater control over the banks due to having a semi-communist/fascist makeup – they have done their best to ban cryptoassets
   1. We have seen a lack of innovations in investment products and outright bans on certain investments in cryptoassets – as well as enforcement from governments
2. But in countries where companies – in particular the financial system through lobbyists have the power to influence the politicians who make the rules – essentially, those that are the other way around from China – we are starting to see a adoption of crypto assets – not as a currency to replace what the central bank provides – but as an alternative asset class that banks can capitalise off through the demand of the population
   1. Banks and most companies have one goal – to make money – every company wants to do this – investment managers and banks do this through what is known as FUM – the funds under management – the more money that people invest in their products, the more revenues they can generate due to percentage charges – in additional to brokerage
      1. I did an episode on the BIS framework a while ago – where they actually defined crypto assets – and talked about the securitisation of traditional assets, such as shares or bonds – in essence – the central banks of central banks sees no problem with the financial system in the west adopting crypto – as long as it is an asset– not as a currency or as a replacement to the fiat monetary system we have in place – as they have their own designs in mind – there can be no competition for the medium of exchange –
         1. It is the building block for confidence in the economy – plus – taxation is the key to this – the government needs one single currency they can domestically track and monitor to make sure they get what they determine is their share of your money through taxation.
      2. Banks will make a lot of money through governments allowing retail investors the ability to purchase crypto related assets through banks/asset managers – which is why there has been large lobbying efforts from institutions like Goldman Sachs and other banks for this regulatory push
   2. In the end – investment managers (fund managers and the banks) will make money through Investment products if people purchase them (i.e. their FUM increases and based around the same % they make more money – 1% at $1bn is more than 1% at $100m) – they will get their hands on anything they can that investors want to hold – and the more they want to hold an asset, the higher the money made from a MER/ICR can be

Now – this is Not advice – general information only based around what product are available in the market – need to take into account your own personal situation - Two types of indirect investments – An ETF with an underlying crytpoasset and those that are considered crypto adjacent

First type – underlying crypto – these are the simplest

1. Let's call this Indirect cryptoassets – In a way, this has been the moment the investment world has been waiting for - ETF Securities appears set to be the first Australian ETF provider to launch a listed security that tracks the spot price of two of the world's largest cryptocurrencies, Ethereum and Bitcoin.
2. This is still Subject to regulatory approval – but if passed - ETF Securities is set to launch into the crypto world – this will done through a partnership with 21Shares, who are the largest crypto provider based in Europe. The agreement will see ETF Securities launch Australia's first Bitcoin and Ethereum ETFs
3. The two listed funds will be able to be purchased through the ASX rather than purchasing through a wallet or off someone in the blockchain:
   1. The ETFS 21Shares Bitcoin ETF and ETFS 21Shares Ethereum ETF will provide Australians with a way to invest in Bitcoin and Ether, via funds operated by ETF Securities, in partnership with 21Shares.
      1. BTC and ETH had been two of the two major cryptoassets classes over the past decade and those with the most traction.
   2. Once they receive final approval, both ETFs are set to trade on the ASX and Chi-X exchange.
   3. This will increase the access for every day investors – but on top of this – access through superannuation for those with platforms that allow access to ASX ETFs
   4. This can have major ramifications – mainly through the increased level of FUM – The more money that can flow into an asset – and the higher the desire = the higher the prices can climb
   5. The actual structing of this asset is unknown – the PDS isn't available at this stage as it is sitting with ASIC – but if it is like their precious metals funds it shouldn't rely on future contracts
   6. In the U.S. regulators appear to be reluctant to approve a spot Bitcoin ETF (which holds actual Bitcoin rather than futures contracts), placing Australia ahead in the game.
4. The second type – is a different Crypto assets – many ETFs are not exactly crypto – it is crypto adjacent = through purchasing companies that deal with block chain and other crypto related activities –
   1. Australian fund management company BetaShares' new crypto company exchange-traded fund (ETF) has been in massive demand due to the underlying securities
   2. There is a Capital Appreciation Portfolio Diversification (CRYP) fund which enables investors to gain exposure to 50 pure-play-listed crypto companies from around the world, such as exchanges, mining companies and equipment firms.
   3. Some of the top companies on CRYP include Galaxy Digital (12.0%), Marathon Digital(11.3%), Coinbase Global (10.7%), Silvergate Capital (10.2%) and MicroStrategy (9.4%).
   4. Investors blasted through the existing ETF record of $5.8 million ($8 million Australian dollars) within minutes and soared to a total of almost $31.3 million ($42.5 million AUD) by the end of opening day, signalling massive pent up demand for crypto exposure on the ASX.
      1. Many people want to demand these assets – so the prices of these funds can be elevated with the increase in FUM
   5. But – since its launce in November 2021 – the price has dropped by 40% - sitting at its low point at around $6.8 when it closed on the first day of trade for $11.19
   6. Plans for more investment products beyond just what has been allowed to date – BTC backed bonds - Goldman Sachs, and a handful of other tier-one US banks, are figuring out how to use bitcoin as collateral for cash loans to institutions,
      1. Emulating tri-party repo type arrangements (a way of borrowing funds by selling securities with an agreement to repurchase them, involving a third-party agent) - banks are exploring ways to follow the same path of not touching bitcoin, like other synthetic products.
         1. Goldman is working on getting approved for lending against collateral and tri-party repo - And if they had a liquidation agent, then they were just doing secured lending without ever having bitcoin touch their balance sheet, whilst still using the price of this as an offset
         2. Goldman is not alone; a handful of big banks are following the trail blazed by crypto-friendly banks Silvergate and Signature, both of which announced bitcoin-backed cash loans earlier this year
      2. The regulatory stance on activity like this remains complicated – but ETF providers are likely to start moving into this space

Things to watch out for – remember all of this is general information only – not intended to make a financial decision based around

1. There is a shift in western countries – an acceptance of major crypto assets – great if you are into crypto – but don't confuse this as another step towards something like BTC becoming a dominant medium exchange – where you will be able to use your BTC to purchase goods at Woolworths or other places
   1. Instead – this is in an essence enshrining crypto assets as something that purely has a monetary value attached to it based around the demand for the product –
   2. Looking at the nature of speculation around cryptocurrencies – there were many uses and hence, many individuals demanding this – people needed it as a medium of exchange for illicit activities, others were thinking that it was going to replace fiat currency, others have purchased it because they think the price will go up – hence a speculative bet – what this round of legislation does is further enshrines the concept that it is purely a speculative asset with no fundamental valuation –
   3. But Crypto ETFs are an inferior product to owning the actual crypto - with prices potentially becoming disconnected from the underlying asset on a daily basis – especially if it is based on future contracts –
      1. It also introduces third party risks – you don't hold the asset but simply the ETF – which represents the price of the asset
   4. But it is an easier method for a lot of people to access ownership in Crypto – hence, demand capacity and asset flow can increase – all else being equal, this translates into an increase in the price
      1. If every person who invested invests 1% of their portfolio into crypto as a hedge/alternative asset – then prices would increase dramatically
   5. But the market is complex and unregulated at this stage – which means that it is still the wild west – especially with volatility – BTC and ETH are not at risk of being some scam with a new coin listing – but they can still be risky due to price fluctuations

The major thing to remember when thinking about to invest is to ask yourself one question: How does this help me achieve my goals?

1. Everyone has different goals – passive income targets, purchasing a property, retiring debt free – a range of different targets – but the question should be always "how does this asset fit within my plan to achieve my goal" – if there is an investment that doesn't fit this plan, then maybe it is something to double check
2. If you are interest in crypto – then these expansions are good news for you – you will have greater access to these forms of investments or if you are looking to diversify

Thank you for listening to today's episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

Welcome to Finance and Fury. Sorry for the break over the past two months – been busy with moving into our newly built place – been in a process of trying to clear out lantana and fallen trees from 5,000sm – that combined with helping take care of my daughter and the excess work in a led up to the end of the year I didn't have time to get an episode out – sorry – all weak excuses aside – in this episode – We will go through Critical thinking for making investment decisions to make 2022 your best year yet

This is a great episode to start off 2022 – as this can become your most powerful ability to make correct decision when it comes to where to allocate your finite resources – everyone on earth has finite resources financially – even Jeff Bezos or Elon Musk has only so many billions they can spend – this is a massive amount – but without creating more – if they spend it all the money runs out –

1. Your individual ability to maximise your wealth - Is based around your ability to decern the correct financial decisions to make time and time again – making just one decision, or getting lucky once often isn't enough to help maximise your wealth in the long term – can help in the short term – but over a long period of time, such as 20-30 years, you will make many decisions – each of these can compound off one another or they can result in set backs
   1. the aim of this episode is to try and teach a method of critical thinking
   2. not only can this be applied to this year to help work towards your financial goals – but for the rest of your life – in every area of your personal life when making a decision – when applied correctly – you will become a master of critical thinking
2. What we will discuss is a process that helps to make a decision based around your personal situation that will equate to the best outcome for your as an individual – hence – this can be the most powerful tools in your arsenal – if you have the ability to make more correct decisions, over time, the further the compounding effects start to accelerate your life outcomes – those previous decisions become a compounding outcome the more of them you make
3. Thinking critically isn't taught – but it is something that we all have the ability to do
   1. We are all born as critical thinkers but this is beaten out of us from an early age – especially through institutionalised schooling – we don't think but learn to absorb and regurgitate information
      1. Kids are in a constant state of learning – which is why they ask 'why' so often – they are trying to learn
   2. In high school – how many times do you ask the question "why" or "how" something works the way it does – most assessment is to get as high a score as possible on a rubric grading system and you get a grade from A to F, or out of 100 – so you lean how to get a high score without critically thinking about the assessment
   3. But it is never too late to start critically thinking

3 Steps to critical thinking – Identify the correct question, evaluate and then make a decision

1. at its core - The solution to critical thinking is really four simple words: Why, does, how and what? These are four simple words that help anyone to develop their critical thinking skills in all areas of life
   1. The key to thinking critically about investments – or anything in reality – is this skill that can be applied to any area of your life – which requires you to think about things – the only way to really think about something is to ask yourself the correct questions, then evaluate these – helping you to narrow down to the correct decision
      1. The very nature of understanding a question comes in the form of understanding the answer – but many of us have no idea about the answer to our own questions
   2. Sure – you can sit back and have someone else spit information at you – which you can blindly follow – but this isn't critical thinking – it is being told what to do and following without a fuss – but this can lead you down the wrong path

Critical thinking is important – allows you to come to the correct conclusion for your own situations

1. Taking a step back and looking at my own personal experience when it comes to initial meeting with clients - Most people I have met don't think about the investment itself and if it is best option for them – they simply want to invest into an asset class because they have heard of others doing it – i.e. their critical thinking around making a decision is that others have done it – i.e. monkey see monkey do – is this real critical thinking?
   1. Some examples – Someone in their mid-60s who is looking to retire in the next few years purchases an investment property that is leveraged at 80% because they went to a seminar about property investment
      1. Why might this be the incorrect decision? Take a minute to think about this – if they are looking to retire, they won't have an income to cover the debt and costs, so the property will need to do all of this – and at 80% LVR – if interest rates rise their net incomes would decline
   2. If you haven't thought up a question and then answered your question at least 10 times on one decision, then likely not critically thoroughly about the initial problem – potentially creating a poor outcome
   3. Which when it comes to investments can be costly – but being able to narrow down your own decision process to get the right outcome is simple if you start to practice and implement this process
2. Our decisions can be influenced easily – it is impossible to avoid a flow of information that aims to influence your decisions – from media, friends and marketing – many brand names in the supermarket sell for double the price of some generic brand even though they have the same active ingredients – like Panadol or ibuprofen
   1. Critically think about it – see some ad about a product or a news story – need to ask questions about it beyond the surface level – in a way, you not to not trust your initial response – but ask further questions about this
3. When it comes to investing - People want to invest to make money – that is simple - but this isn't thinking critically
   1. There are plenty of situations where someone puts money into something and it goes up – was this situation critically thought through or was it luck? This can then reinforce the behaviour to not critically think
4. 3 Steps to critical thinking – Identify the correct question, evaluate and make a decision
   1. Critical thinking is about asking and then answering questions – this is where the core four words of Why, does, how and what come into play
      1. Answering questions isn't about simply wrote answering based around what you assume the correct answer to be – but taking the time to answer each in full
   2. A simple rule I have for myself when critically thinking about any subject or question – is asking at least 10 questions prior to making any decision – and then aim to answer them in an unbiased way – if there is an opportunity cost to this, i.e. another alternative – do the same for that and see which answers match best with what I want
      1. This can be hard – the very way we search questions can be biased and result in a biased result
      2. Works in a chain – example – one question can open the door to other questions – and it should – once you get to the bottom of one answer – this will naturally open the door to many other questions
   3. You need to evaluate each of these questions through answering these in full – once you have your answers – you hopefully have thought through your situation to make the correct decision

Let's look at some Examples – First step it to determine what you want – through critically thinking about it – ask yourself questions – say you want to invest, and you come to the conclusions that this is to generate a passive income to retire early – then you have to make a decision on what to purchase

1. Property – I want to buy an investment property – why? To make money is not a good enough answer – It goes back to the basics of investing – everyone invests to make money – so you need to deeper in questioning your motives and what this property can do for you - what do you want it to do for you? Is it to get Capital growth or an income return?
   1. If income, does a property help this? Go further – what income can you get? Do the calculations:
   2. Let's look at an average apartment investment property in Brisbane and debt servicing and run through some numbers – so you need to ask yourself some questions, like: How much are you purchasing the property for? What is your estimated rental income? What will it cost you in outgoing cashflow? How long do you plan to hold onto it? What level of capital growth do you need to make it worthwhile?
      1. Let's say the initial purchase price is $550k – you would need to cover around $18k stamp duty plus a $110k deposit – so you need $128k of initial capital and you end up with a $440,000 loan
      2. You could rent this property out for $480 per week or $24,960 p.a. which after agent's fees of 8% is about $22,963 p.a. in net rent – for outgoings, you have rates and BC which say are $3,500, landlord insurance at $1,500, other outgoings like utilities and maintenance at $2-3k p.a.

• Your total costs are about $7,500 plus monthly PI interest repayments of $2,050 assuming a 3.8% interest rate on an investment loan – so what do these numbers translate into: A net cashflow loss of about $9,140 p.a. – so you would need to put $760 p.m. of your own cashflow into maintaining this property – this brings up another question: is this feasible from your current cashflow?

1. Also – what are you after if it is income then this property may not be for you – is it capital growth? Then do you expect this property to at least go up by $10k in value each year?

1. These are all initial questions – but get a deeper understanding about the dynamics of property
   1. What affects capital growth? Interest rates, number of properties and demographics = supply and demand - If you do your research and come to the conclusion that it is Low interest rates and demographics – then you are better positions to answer the next question in critical thinking – are interest rates going to remain where they are or go lower to help
      1. Are apartments in the area susceptible to an increased supply: available land for development and the demand for this
   2. Another question to ask: What affects net income – interest rates and the property being tenanted and in demand – if interest rates go up by 1%, your net cash outflow increases from $9k p.a. to $12,300 p.a. or around $1k p.m. – so can you afford this? Also, is this property in an area that is highly demanded by those that rent in terms of demographics?
2. Once you have done this exercise and answered each question that comes to mind – time to evaluate –
3. If it ticks all the boxes and you get the answers to satisfy your conditions – then you can make an affirmative decision – but another final question should always be: 'is my capital better put to use elsewhere'? Which brings up an alternative

1. Shares – I want to buy shares – Why? Again, making money isn't a good enough answer – what do you really want from it?
   1. Reason for purchasing shares – capital growth and income through dividends – which one is more important to you?
   2. Do you know what you are doing? This is important – as shares can be rather volatile – if you don't know what you are looking for with individual share purchases, is there a professional manager you can outsource your decision to?
   3. Do you need to diversify and outsource your investment decisions through purchasing an ETF or managed fund?
   4. Go through the numbers: Say you take the $128k of capital in the property example and invest it in a few ETF's?
      1. Depending on the ETF, you could comfortably earn around $6,000 of positive income p.a. – this can be reinvested into the investment over time helping the investment compound

Really – it comes down to what you want to achieve and critically thinking through your decision

Critical thinking summary – Three stages – Identify the correct question, evaluate and make a decision

1. Critically thinking is about asking yourself the important questions and answering them – then once you have your answers compiled – you can make a decision –
   1. Write each of these down – keep track on paper and not all in your head as this can lead to information fatigue
2. Try not to get bogged down – it can be hard with information overload – but in a way this is a good exercise – it is practice – the more you practice this process the more it can be refined – helps to make quicker decisions and come to a conclusion
3. It can be overwhelming at first but don't let this put you off – think of it as practice - if you are having trouble – set a limit of questions – at 10 or 15 – if you reach this, then more on – taking no action can often be worse than being inactive

Thank you for listening to today's episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

Welcome to Finance and Fury – In this episode, we will be looking at the future of property prices based around recent changes in lending assessment, bond yields and what this means for interest rates

1. It comes as no surprise when I say that property prices have gone up a lot over the past 2 years – well above forecasts – at the same time, and in a causal manner, interest rates and bond yields have declined to record lows – but is the party coming to an end sooner than expected? As there are some emergences in the bond markets which may spell an interest rate increase ahead of schedule – putting downwards pressure on property prices -
2. There is a bit to unpack here – do so in three parts – we will go through the current state of the property market – then what happened last week in the bond market in Australia – then what this means for central bank policy on interest rates

To start with - Looking at housing prices – Almost in lockstep – prices have increased at rapid rates across the world, reaching new heights in many cities –

1. But rural and urban markets have shared in the spoils - which is noteworthy for two reasons
   1. First – lockdowns and movement restrictions have given rise for remote working – which has actually weakened the case for urban housing – but yet prices in urban areas continued to rise
   2. Second - housing affordability in cities was already heavily strained even before the latest irrational exuberance in property took hold - yet the lack of affordability of homeownership for large parts of the population has evidently not been an obstacle to price increases
2. Why is this the case? Record low financing costs have increased borrowing capacity for property buyers –
   1. Plus – there is an entrenched expectation that most people hold when it comes to property in Australia – that is of long-term value gains which has made owning a home so appealing that the price level doesn't seem to matter – FOMO – it can be hard to wait to buy, if you think that in doing so the prices will be 10% higher next year, as this is what you are used to seeing
   2. These higher prices have led to higher household leverage levels - as the current acceleration in mortgage volumes clearly demonstrates – Data from CBA shows that across the country, the new average mortgage across the whole of Aus (higher in Syd and Melb, lower in NT) stands at $580,900 – which is up by around 16%, or $80,000 over the past 12 months – is it any wonder why prices have gone up by so much?
      1. This has exacerbated worsening affordability, unsustainable mortgage lending practices, and a rising divergence between prices, household incomes and rents – all of which have historically served as forerunners of a housing crises
      2. But as long as financing costs trend toward zero, property prices, incomes, and rents can continue to decouple from the real ability of borrowers to cover these debts
   3. These have been trends just not seen in Australia, but worldwide - As a result, the growth of outstanding mortgages has accelerated almost everywhere in the last 12 to 18 months, and debt-to-income ratios have risen—most markedly in Canada, Hong Kong, and Australia
      1. Due to this - pressure is mounting on governments and central banks to take action – even before lockdowns - Lending standards were being relaxed due to ever declining interest rates over the past decade – Overall, housing markets have become even more dependent on very low interest rates, meaning a tightening of lending standards could bring price appreciation to an abrupt halt in most markets
      2. New entrants into the property market have to borrow increasingly large amounts of money to keep up with higher prices – or even people wishing to upsize to a new property - As a result, the growth of outstanding mortgages has been growing due to the relaxed lending standards and falling mortgage rates.
   4. Therefore - ever-higher property prices and leverage levels imply ever-higher risks due to the property market being under the spell of a dangerous narrative – that the party will keep going
      1. The main barriers for borrowing that most households face is now based around creditworthiness – i.e. how much people can borrow – so once that obstacle is cleared, coupled with the expectation of ever-growing house prices – this has exacerbated the FOMO making homeownership look attractive regardless of price levels and leverage that it costs
      2. This rationale may keep markets running for the time being – whilst interest rates are low - But it's not sustainable in the long run. Households have to borrow increasingly large amounts of money to keep up with higher prices – resulting in higher levels of principal repayment each month – on top of the risk that interest rates rise
   5. Does all of this mean we are in a bubble? – looking at a paper released by UBS on the Global Real Estate Bubble Index - Price bubbles are a recurring phenomenon in property markets across the world – but the term bubble is a little tricky
      1. The term "bubble" refers to a substantial and sustained mispricing of an asset, the existence of which cannot be proved unless it bursts – this is because all because the price of something increases massively, to almost unsustainable levels – it doesn't mean that it is a bubble – because ironically it is only a bubble if it pops – if rates stay near zero, or even go negative and stay there, property prices can continue to climb
      2. But historical data reveals a pattern that exists with a bubble in the property market – the most typical sign is that of a decoupling of prices from local incomes and rents, as well as occurring at the same time as imbalances in the real economy, such as excessive lending and construction activity
         1. But again – even prices in Sydney are not considered to be in a bubble unless there is a turnaround in interest rates – otherwise the decade-long upward trend of house prices is likely to continue, given ongoing population growth
         2. But there are some risks to the property market now emerging – coming from APRA and the RBA

Over the past month - APRA has started trying to reduce lending risks – directing banks to tighten up their assessment

1. Price growth has clearly outpaced local incomes, stretching affordability and thereby increasing dependence on easy financing conditions even further. The growth of outstanding mortgages is accelerating again, as households are taking advantage of historically low interest rates – even people who own property are refinancing to make renovations on their existing property – Therefore - A tightening of lending rules would likely result in a setback for prices.
   1. It is now recommended by APRA that banks increase their 'buffer' from 2.5% to 3.0% on top of their loan serviceability rate
      1. This is the assessment that banks take when you apply for a loan – they look at what you could afford based around this serviceability rate, not the current interest rates
   2. However - Only two years ago, APRA's loan serviceability floor was set at 7.25% - this was more or less a hard fix – but at interest rates dropped, pressure built to change the rules which took force in 2019 -
   3. Today - On a 1.99% home loan, a borrower would be assessed on their ability to repay the mortgage at an interest rate of 4.99% - the interest rate plus the new APRA buffer of 3.0%
      1. In reality - serviceability rates are also often calculated on standard variable rates, which are higher than discounted rates that most banks offer – but it is still lower than 7.25%
   4. This change is expected to reduce the borrowing power of property buyers by around 5%
      1. Therefore, using some simple maths – each 0.5% of serviceability rate equates to 5% of borrowing capacity – As an example, someone who could borrow $1 million under the old buffer could now only borrow about $950,000 – but now compare this to the rules prior to 2019 – if the serviceability rate was 7.25% compared to say a standard variable rate of 5.5% (2.5% standard rate plus 3%) – this is 17.5% more that people could still borrow, even after the tightening of the lending rules
      2. While the banking system is well capitalised due to their ability to bail in with equity or capital notes - increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building
   5. The expectation is that housing credit growth will run ahead of household income growth in the period ahead – this means that more tightening could come to help curb the level of leverage – where the buffer rates increases to 3.5% and beyond
      1. What is interesting, is that these moves from APRA came after a recent RBA's post meeting statement flagged the importance of loan serviceability buffers –
   6. Which brings us nicely to the new development with the RBA -

Looking at The RBA - have said they will keep interest rates on hold until 2024 – giving forward guidance to the market, that rates will be on hold until at least until this time – to achieve this in practical terms through monetary policy, the RBA has been helping the bond markets through market operations, purchasing bonds of the secondary market to keep yields at their current target rate for 3 years at 0.1% - by any other name this is called QE

1. But going back to Thursday last week – Or on the 28th of October depending on when you are listening - The RBA made no offer to buy the next trance of government bonds – they declined to buy the April 2024 line of bonds as part of their regular market operation, even though the yields of these bonds were already above their target of 0.1%, sitting at 0.16% - This created a shock to the market – Central banks had given clear guidance that they would do whatever it took to keep the yields of these bonds in line with the cash rate – but all of a sudden, they reneged on their agreement with not a peep
   1. As expected - the market responded poorly – by dumping these bonds, resulting in the price dropping and pushing the yield up further to 0.30% -
   2. The market waited to see if this was just a blunder – or if they were waiting until Friday – Friday came and no purchase were made – so more of these bonds were sold off and the yields spiked even higher to 0.67%
      1. Remember that a yield is the % return based around the price of the bond
   3. The fact that the RBA out of the blue decided to not purchase these bonds, which are a core part of their stimulus programme – started stoking market speculation that there is going to be an early hike in interest rates than previously thought
      1. This failure to deliver on what the RBA has promise has fuelled markets expectations that rates will have to rise much earlier than 2024 – based around the current pricing – it appears that the consensus is that there will be a 50 basis points of tightening by mid next year, and 100 basis points by year end – so interest rates will be around 1% by the end of 2022 – rather than being 0.1%
   4. Offshore events added to the drama and probability that this may occur - with the Bank of Canada stunning markets on Wednesday by ending its bond buying altogether and flagging a hike as soon as April 2022. We also had many Central banks, including is New Zealand raising the reserve cash rate by 0.25%
   5. The RBA is now under intense pressure to do something at its monthly policy meeting at the start of next month – where they will either defend its yield curve target, soften it, or drop it altogether.
      1. The RBA currently aims to buy A$4 billion a week in bonds as part of QE programme – This was always going to be reconsidered in February 2022 – But this recent unexpected withdrawal from purchasing bonds could signal the end to this plan sooner rather than later
      2. This action signals that the first-rate hike back to 0.25% could occur sooner than later, compared to 2024 – followed by four more moves to 1.25% by the third quarter of 2024
      3. Overall – if any increases in interest rates occur, then it can be expected that these will be shallow and gradual based around a tightening cycle – it is unlikely that the RBA will increase interest rates to 1.25% in one go next year - given the elevated level of household indebtedness
   6. But this increase in interest rates ahead of schedule does put a potential downwards pressure on property prices
      1. Given that an increase by 0.5% in serviceability rate creates a reduction of 5% in borrowing standards – an increase to 1.25% for the interest rate results in around 12.5% less borrowing capacity – which means that the part may be over for ever increasing property prices – as people can borrow less and the costs to borrow become more stark
      2. but on top of this, an increase in servicing costs - If the average mortgage is $580,900 – then an increase of 1.25% results in an additional $7,261.25 p.a. in interest repayments – there are around 10.3m properties in Aus, and around 6m of these have a mortgage attached to them for which this average is based around – doing some rounding, that means that an additional $43.6bn will be spent on interest costs of owning a property
      3. This takes funds away from other spending in the economy and puts a downwards pressure on GDP spending

Summary –

1. Property in Australia is being spurred by interest rates, no surprise here – due to the increasing amounts that people can borrow, increasing the capital available to big her amounts on property – it is supply and demand
2. If the RBA fails to follow through with their commitments to keep the 2-year bond yields at 0.1%, instead letting this spike to closer to the free market rate of 0.67% due to not purchasing these bonds – This could mean that an interest rate increase is likely to happen sooner rather than later –
3. If increases in rates occur before is anticipated, this will have major impacts on the market –
   1. Servicing costs of households will increase
   2. From an Asset pricing perspective – prices of property could decline – or at the best reach a stagnant growth until wages and immigration rates catch up
   3. The market is currently addicted to almost free money – needs this to continue for price growth to continue, if not the prices of assets would come back in line with the fair value that interest rates represent
      1. The current price of property is technically a fair value based around record low interest rates – if interest rates go up, then the fair prices, or market price, would go down for property – if rates go negative, then prices can continue to grow
   4. Will the increase of rates and the decline in property be this week – probably not – but can we trust when the RBA has been telling us? No - the forward guidance has been that they won't increase rates until 2024 – either they will do this on the exact day these bonds mature – in April – or there is a chance that this occurs ahead of time –
   5. Either way – this is a warning – for those new home buyers – if you are purchasing for the first time – make sure you can afford repayments at a buffer of 1 to 2% interest rate above your current margin
      1. If these market predictions come true, it would dampen the potential price growth that property has been going through – so don't be banking of some short-term capital growth from a property purchase – to purchase now and be able to accumulate equity quickly to upscale
         1. Based around the rough numbers from CBA – borrowing declines by 5% per 0.5% in interest rates – so prices have the potential to decline – putting pressures in LVRs
      2. For existing buyers as well – same thing applies – make sure your cashflow can afford the interest repayments – if anything, this is an opportunity to get ahead of mortgage repayments before the interest rate cycle reverses

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https://www.ubs.com/global/en/wealth-management/insights/2021/global-real-estate-bubble-index.html

https://tradingeconomics.com/australia/2-year-note-yield