Rising Interest Rates, a Declining House Market & More

Things are starting to bite, and all at once. We have declining house prices in New Zealand, rising interest rates, spiralling inflation, supply and labour shortages, consumer confidence tanking, and on the flip side, startlingly low rates of unemployment. Will this all add up to an economic recession?  If so, can we bounce out as quickly as we bounced in? Here’s Tony’s take.

Rising Interest Rates

As Tony has said previously, central banks overstimulated their economies in 2021. He believes they kept interest rates too low, with too much money printed, which has caused economies to overheat.

Tony believes the unemployment rates are too low, and the pressure on resources is extreme. To add to this, we now have extra pressure from China’s supply chain interruptions and soaring food and energy prices due to Russia’s invasion of Ukraine. Central banks must accelerate increases in interest rates and slow down their economies as quickly as possible.

Tony admits that the worse the economic data gets in the short term around the world, the better. It means the interest rates won’t have to go so high and stay up for so long. What’s more, as we approach the second half of 2022, interest rates are rising further. Everything is being accelerated and condensed in time, leading to a bit of a maelstrom.

Is There Hope?

So, is this a perfect storm or a case of a short, sharp tornado? Tony believes the crunch in consumer spending is happening, our main hope for the future. Falling house prices and rising interest rates in New Zealand are crunching consumer spending, as is the increased cost of living. Tony believes that the cost of living increases negatively impact all of us, while rising interest rates affect only a portion of New Zealanders.

As an economist, the thing that gives Tony the greatest hope that things will to start to look better within 12 months is the fact they’re looking worse right at the moment.  He sees light at the end of the tunnel and believes there is a good chance that the mortgage interest rates will have peaked (for maybe all but the one-year fixed rate) by the end of the year.

What is an Economic Recession, and What is its Impact?

What will it mean for New Zealand if we have an economic recession, and how long will it stick around? Tony says that if we have a recession, it will likely be short-lived. Tony defines a recession as consecutive three-month periods when the economy shrinks. Even if the economy shrinks by 1.5%, 98.5% of economic activity continues.

The main impact of a recession is businesses laying people off because of bloated balance sheets, too many staff, and inventories that are too big. But Tony says that this time around, very few businesses have too many staff, apart from real estate agencies. Instead, they don’t have enough staff and need to hire more. That’s a significant insulating factor for the economy. Another is that many businesses don’t have the inventories and stock levels they want. These businesses are still scrambling to get more raw materials.

Tony notes that New Zealand’s export prices are solid. Part of our economy benefits from the unfortunate circumstances in Europe. Food prices are high, and Fonterra recently projected its highest ever pay out to its suppliers.  So Tony is optimistic that many businesses will do fine.

Interest Rates/ Monetary Policy

In a previous update, Tony stated “excessive monetary policy easing turned housing into a pyramid scheme,” he now elaborates on this.  To put it simply, Tony believes that people don’t want to experience a fear of missing out (FOMO), which influences attitudes towards the housing market. So, when people see New Zealand house prices and average people making easy money from properties they bought one or five years ago, their FOMO drives them to purchase a property they had no intention of buying. They may continue to do this until they realise they’ve made a mistake. They ask themselves, ‘What was I thinking?’ then start pulling back from the new builds and selling the properties they bought all those years ago.

This pattern is what Tony tries to capture with his FOMO and FOOP (fear of overpaying) readings in his monthly survey. In the frenzy, the proportion of real estate agents in his monthly survey saying they saw FOMO, peaked at about 92% in very late 2020. In the survey he currently has underway, that percentage now sits at 3%, showing that only 3% of agents think people have FOMO.

In Tony’s FOOP reading last October, 19% of agents reported that people were worried that they’d buy and then New Zealand house prices would fall. Now, that percentage sits at 77%. Tony says that those price expectations and fears moving around could set a market up and down. And crypto markets are the big extreme of all that

Tony’s Predictions on the Monetary Policy

The banks have just completed a round of fixed interest rate increases. That means the 1 – 5 year fixed mortgage rates are between 3 – 3.5 % higher than they were at the low points (let’s say the first half of 2021). Tony thinks the interest rates will only go up a little further for the 2 – 5 year terms. The reason is that, although the Reserve Bank’s cash rate is only 2%, they project 4%.  The markets have already factored in at least a move to slightly higher than 4%. So the fixed interest rates reflect expectations of what will happen in the future, not what is happening now.

Central banks have explicitly said they would raise interest rates quickly and may risk raising them too far and too fast if doing so would reduce inflation. Such a rise could shorten everything in time. Our central bank now predicts interest rates will reach their peak in mid-2023. Tony, however, thinks it may be even sooner than that. He says people must get through this tight 12-month period of the high cost of living increase and the rise in debt servicing costs. The disaster, he says, will be the people who can’t quite make it through the last six months of servicing their mortgage, but he hopes it won’t be too many of them, given the excellent job market out there.

Housing, Construction, and Supply

We are in a declining housing market. How low does Tony think it will go?  Tony says the average New Zealand house prices are down by 7.7%, with Auckland down to about 12%. Wellington is down by 11%. He thinks Auckland and Wellington are ahead of the pack, timing-wise.

Tony believes the significant change forthcoming is not house prices but construction. He explains that the number of consents issued for new-build houses sits at about 51,000. That number will drop sharply over the next six, 12, or 18 months because many people don’t want to risk signing up for a new build when they hear it’s difficult to get trades people and building supplies.

Tony says the construction sector is turning very quickly. Trades people are choosing to work in Australia, where it’s still booming. According to what he’s heard, holes are starting to appear in the production schedules for some building companies. Unfortunately, this means there will be some weeding out in the sector. Tony’s family had experiences with these circumstances in the 1970s, which is why he strongly warned about what was to come in construction just over a year ago.

Tony’s Insight about Investors

On March 23 last year, the Finance Minister announced tax regime changes for investors and everyone expected them to put their rents through the roof. But Tony has repeatedly said there is no evidence of a wave of investor selling. In fact, according to his monthly real estate surveys, Tony thinks there is a decrease in the number of investors looking to sell. They can see that the market is weak. Most of them have held a property for a good number of years, they’ve been planning to keep it and they can choose which cycle they sell it in.

So, there is no wave of investors placing properties on the market because most of them do not have to sell. There also won’t be many mortgagee sales from those who bought properties in the last couple of years because job security is quite good.

Tony says the biggest woe in the market will be in the new build space. Too many property developers are too leveraged, inexperienced and optimistic. He believes investors expecting bargains in existing properties should look at the partially completed new development area.

The CCFA Changes

What effect will changes to the Consumer Credits Contracts and Finance Act (CCCFA) have? Tony believes that we won’t likely return to the environment we had before December 1 2021, when the CCCFA changes went into effect. Banks remain uncertain about irresponsible lending as the legislation doesn’t specifically define it.  However, he thinks there will be a slight improvement because it’s become clear that banks shouldn’t be counting regular savings as an expense. Now there’s some allowance for a change in spending habits going forward.

Tony believes we’re not in the depths of a credit crunch which occurred between October to February. He says things have gotten easier but nowhere near where we were previously. Credit is still hard to get. Many buyers will find they still can’t get a mortgage for some time.

Tony thinks there is about a 40% probability that the Reserve Bank will tweak the LVRs before the end of the year. They’ll be looking at the speed with which house prices are going down and the weakness in consumer spending.

Final Thoughts & Advice to Kiwis

To sum up, Tony says that we are all affected by things we can’t change. None of us can change the inflation rate, rising interest rates, what’s happening in Europe, or what’s happening in China. When you’re surrounded by things you can’t change, it’s natural to feel hopeless and worried. Subconsciously, however, you do feel there is something you can control.

This anxiety is Tony’s fear. He explains that psychologically, we tend to embrace these trying times with negative thoughts because it allows us to inject some power and feeling of control when so much else is uncontrollable.

Tony encourages Kiwis to understand that there is power in talking negatively to others. He wants people to try and step back from it. People think it won’t end when times are booming, so they buy and borrow too much. They start thinking negatively about bankers because they won’t lend them what they want to borrow.

Then when things ease on the other side, people get worried and sell too much. They put off plans too long and blame the banks for lending them too much. We always look to blame somebody outside, he says. Tony wants people to remember that things move in cycles and to focus on things we can control.  He suggests people cut their spending, and delay what they were going to do such as overseas holidays, to free up some finances for the weekly shopping for the coming 12 months.

Find Out How a Changing Market Impacts You

As always, if you have questions about how a changing market impacts you and your home loan structure, we’re here to help. Book a free chat with your local consultant today

*Please note – Tony Alexander is an independent economist. His views are his own and not necessarily shared by NZHL or vice versa. Tea with Tony is brought to you by NZHL in a sponsored capacity.