This week, markets face what could be the most import week in recent memory.

With the Fed, Earnings and economic data set to be released.

There is a plethora amount of news for markets to digest this week, with the biggest of which will be the Fed Reserve’s midweek meeting.

During the past few weeks, there was one point that many experts were convinced a full point rate hike was coming. However, Fed officials pushed back on that view and economists widely expect a second three-quarter point hike to follow the one last month.

With the markets already pricing in a 0.75% rate hike in the US this week, the focus shifts to what happens in September and if inflation has peaked or if it is still on the rise.

With many of the largest companies in the US reporting.

Microsoft Tuesday
Google Tuesday
Meta (Facebook) Wednesday
Apple Thursday
Amazon Thursday

In all, more than a third of the S&P 500 companies are reporting this week.

Couple with this, are several economic reports, which should provide further indications on whether the economy is heading toward, or is already in, a recession.

Many experts are saying that the outlook from these bigger companies will be more important than the actually earnings they post. This coupled with the statistical reports, which will be backward looking, will provide volatile conditions for the market.

What does this me for you?

Inflation has not yet peaked, with many experts pointing to inflation peaking in the next few months (if it hasn’t already).

Interest rates in Australia will continue to rise.

For mortgage holders this presents more pain to the family budget, but conversely this provides opportunities for retires to take less risk and receive a greater income.

However, all the focus in Australia will shift to property prices and family budgets.

Many experts have been screaming for a long time that many Australians have over stretched themselves. However, with property prices rapidly rising over the past few years, these “doomsayers” were drowned out.

We have heard that in June 2019 14.6% of new mortgages were written at a debt to income ration of more than 6x.

However, as rates remained at all time lows, this created an environment where many were over extending themselves financially, as we saw close to a 25% of loans in the December quarter 2021, written at more than 6x household income.

From the time the RBA slashed rates to the end of the March quarter of 2022, over 225,000 loans at a debt to income ratio of more than 6x household income were written. This figure will almost certainly rise to well over 250,000 when the figures for the June quarter are released in the coming months.

So to listen to real estate agents or property spruikers regularly outline the $ value of homes that are owned outright.

However, for generations the numbers have been pretty consistent with a 1/3 of homes owned unencumbered, 1/3 of homes owned with a mortgage and a 1/3 of Australians are renting.

These figures will obviously be skewed in the years to come, with Australia’s aging population.

However, the fact remains, that there are generation of home owners that have not experienced a rate rise, have never had to review their family budget and tighten the belt, and as illustrated above over 250,000 home owners have over extended themselves coming into a rising interest rate environment.

The housing affordability my have also contributed to Australians over extending themselves to “just” get into the property market.

A recent research report showed that more than 1/3 of recent first home buyers were pushed beyond their budget in order to afford their first home.

Let’s jump in and look at an example…

A household that is debt free aside from their mortgage and earn $100k per annum.

If this household borrowed 6.8x their household income on a 3 year fixed rate loan at 1.8% would consume 29.3% of the household income.

With the cash rate now having risen 1.25% and it is widely tipped to rise another 0.5% in August, a mortgage rate of around 4.25% is likely to be roughly where rates will be at in coming months.

At this level, the mortgage repayments would be consuming 40% of the gross income of our example.

However, at this level we may not be through the entire rate rise cycle.

When mortgage rates hit 6%, our example household would be spending close to 50% of their gross household income on their mortgage.

Couple rising rates, tightening budgets with falling property prices, we have a perfect storm that will push many Australians into difficult financial positions.

Especially when we consider the numbers coming out of New Zealand, many are asking are we next?

Wellington prices are down 17% despite listings being up 93% year-on-year, and Auckland prices falling 13%.

We understand that our politicians are starting to get these numbers presented to them.

We have seen in NSW that the state Government is moving from a stamp duty to a land tax, to ease the affordability and entry into properties (whilst also getting regularly tax to pay down their debt).

On a Federal level, I would not rule out a mortgage “holiday” again, and a crackdown on lending criteria. e.g. the serviceability and limits on how much people can borrow at what levels.

You will start to hear a lot more communication from the big banks in coming months, talking about if you are struggling to repay your mortgage don’t put your head in the sand, talk to us so we can support you. The banks are worried about the amount of foreclosures and the bad publicity that come with it.

These numbers are very confronting and in time will present a significant challenge for these households if rates do continue to rise, but more than that it will force the banks and the government to do some soul searching on how to address this in the inflationary environment.

However, this backdrop will provide opportunities for many investors that are looking to invest in the property market and take advantage of some of these Australians that will find themselves in a difficult position.

Remember not to make long term financial decisions, based on short term metrics.

If you think you are one of the households that have over extended…. do not wait to review your budget and discuss your options and solutions.

If you are an investor looking to get all your ducks in a line… do not wait… make sure you have your financials, pre-approvals, and investment strategy ready.

Sources:

https://avidcom.substack.com/p/rising-rates-and-australias-over

https://www.newshub.co.nz/home/money/2022/07/new-zealand-sees-largest-drop-in-property-prices-on-record-trade-me-figures-show.html

https://www.aihw.gov.au/reports/australias-welfare/home-ownership-and-housing-tenure

https://www.savings.com.au/home-loans/by-the-numbers-australian-home-ownership-tenancy-statistics

https://www.mpamag.com/au/news/general/how-many-homes-in-australia-are-mortgaged/411240

https://www.afr.com/markets/equity-markets/asx-to-follow-wall-st-lower-iron-ore-jumps-20220725-p5b47e

https://www.cnbc.com/2022/07/22/markets-face-what-could-be-the-most-important-week-of-summer-with-fed-earnings-and-economic-data.html

Market Update