Weekly Reports | Sep 27 2019
Weekly Broker Wrap: monetary policy; house prices; banks; and copper.
-Potential for unconventional policy measures from the RBA looms closer
-Significant acceleration in credit and easing of lending standards required for a strong rebound in house prices
-Banking sector squeezed amid further official rate reductions and open data
-Copper demand from renewable energy greater than many envisage
By Eva Brocklehurst
Monetary Policy
The Reserve Bank of Australia has recently outlined the options for consideration if economic growth fails to garner momentum and the unemployment rate rises significantly. Unconventional measures used by global central banks including taking official rates negative, purchasing government bonds or private assets (quantitative easing), funding banks to support credit or intervening in the foreign exchange market.
UBS suspects the RBA would begin by injecting liquidity, were it to undertake unconventional policy, by increasing both the size and terms of its open market operations. The primary aim would be to lower risk-free rates across the curve and reduce term funding costs for lenders as well as maximise the pass-through of cash rate reductions. Lower cash rates would also put downward pressure on the Australian dollar.
The RBA deputy governor Guy Debelle has recently indicated it would be helpful if the Australian dollar would depreciate further, both in terms of economic growth and also inflation. Dr Debelle has also noted that other central banks use of unconventional policy occurred when official rates were reduced to 0.5% or lower. UBS expects the RBA to reduce the cash rate to 0.25% by May 2020.
House Prices
Morgan Stanley expects a sustained recovery in Australian house prices is likely to be linked to fiscal policy, not re-leveraging. Regardless of recent positive house price signals, the broker believes challenges continue, linked to volume, credit and demand. Demand has improved somewhat but remains affected by record low turnover.
The main issue about whether a sustained housing recovery can occur centres on whether demand can absorb a higher price and volume environment. The credit environment is tight and, linked to this, Morgan Stanley's analysis shows that loan approvals are the leading indicator of both house prices and retail sales.
Another challenge is the continuing strong supply of new dwellings, particularly apartments. The broker suggests a trough in house prices, not a large bounce, remains the most likely scenario. A reduction in official interest rates will improve mortgage serviceability but there needs to be a significant acceleration in credit along with an easing of lending standards for a strong rebound, and neither is expected.
Banks
Further reductions in official rates from the RBA will add to margin headwinds and require even more re-pricing of home loans, Morgan Stanley asserts. This creates downside risk to forecasts for bank margins in FY20 and FY21. The broker expects the RBA will reduce the cash rate by -25 basis points at both the November and December meetings although the implied probability of a rate cut in October is recognised at around 80%.
The broker calculates that over 35% of major bank deposits already have interest rates below 50 basis points, meaning deposit spreads will be squeezed further. Morgan Stanley forecasts major bank margins to fall by an average of -7 basis points in FY20 and -2 basis points in FY21, with downside risk if re-pricing does not offset the headwinds from further rate cuts.
Two thirds of the funding for banks comes from customer deposits with half in the form of at-call deposits. Hence, Credit Suisse reports, it goes without saying that each subsequent reduction to official interest rates reduces the price-addressable deposit base.
This makes it more difficult for banks to maintain margins and pass through the full reduction in the cash rate to loan customers. The broker calculates that at-call deposit rates need to be reduced by around -51 basis points in order to offset a -25 basis points reduction in cash rates, and to pass through fully to standard variable loans.
Macquarie suggests banks need to focus on expense management to support profitability. The broker expects disruption across the industry to result in lower returns while the major banks face the greatest risk in the high-returning business verticals such as foreign exchange, mortgages and payments. As data sharing becomes more widely accepted Macquarie assesses the competitive landscape will intensify.
Customers are more likely to choose products that offer convenience and price as opposed to simply selecting sub-par product offered by their current financial institution. The introduction of open data is likely to have limited consequences on incumbent banks and, the broker assesses, should contribute to better transparency and more seamless movement between providers.
Nevertheless, the structural headwinds create some uncertainty about the sustainability of the long-term returns of the banks. Given the sector is trading at around -10% below the long-term average, Macquarie calculates structural headwinds are partially reflected in current share prices.
Copper
Analysts at ANZ Bank suggest the outlook for copper is not as bad as the macro economic environment implies. The US/China trade conflict continues to weigh on sentiment, amid signs of weaker economic growth globally.
Taking into account the shift in investment towards renewable energy, the analysts find that copper consumption is actually better than the investment data indicates. Traditionally, grid investment in China is used to calculate copper demand from the power sector. Year-to-date, expenditure has been down -14%.
Apparently, five times more copper is used in the construction of wind generators than in coal-fired or hydro generators. Overall, the analysts calculate copper demand from the sector is up 20% in 2019. Supply issues are expected to push the copper market into deficit so downside for the price is envisaged to be limited. Any resolution of the trade conflict should allow prices to respond positively as well.
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