Macro Wrap-Up

Three Countries Which Have Never Been in My Kitchen

Topics - Macroeconomics

${ numberSection } ${ text }
Three Countries Which Have Never Been in My Kitchen

Australia, Canada, and Sweden don’t seem to have much in common. 1 1 Close The title should be in the form of a question. Get well, Alex Trebek! They are on different continents, enjoy different sports and speak different languages. 2 2 Close Some might argue that two of the countries speak the same language with different accents, but I can’t tell. They are all medium-sized, developed economies but excel in different areas. Sweden is known for heavy manufacturing, Australia for mining, and Canada for ice hockey. 3 3 Close Like Australia, Canada also is very strong in natural resources, but also manufacturing, particularly in the auto sector. Sweden also has some pretty good ice hockey players. If you read economic and market commentary, however, it might make you think they’re all the same country. All three have moderate growth, low interest rates, and low inflation. And all three have been accused repeatedly of having housing “bubbles.” For years forecasters in all three countries have been making dire predictions of what will happen when these so-called bubbles burst. For years these forecasts were wrong, but we finally may have seen the top. Perhaps, fittingly, it’s happening at the same time in all three countries. Before you hide in the bunker in the basement of your once expensive house, let’s take a look at what happened. 4 4 Close Not sure why I assumed everyone who reads this lives in one of those three countries.

The ingredients for house price appreciation are some mix of limited supply, possibly because of regulation, an expanding population of potential new home owners, outside investment and perhaps most importantly, easy credit. What Australia, Canada, and Sweden share is not the same combination of local supply and demand conditions, but rather a similar macro-economic backdrop. All three countries had strong housing markets in the early 2000s but managed to escape the financial crisis relatively unscathed. 5 5 Close Relatively is the key word here. They did a lot better than, say, Spain, Ireland, Iceland or the U.S. Nonetheless, growth slowed and authorities responded by lowering rates and adding some fiscal stimulus. The economies recovered, but inflation stayed low partly because other economies around the world were slow to recover and there was plenty of excess global capacity. Central banks in all three countries tried to bring rates back to pre-crisis levels, but these efforts failed. Falling mortgage costs led to rising debt levels, but household monthly payments remained manageable because rates were so low. The combination of easy credit and healthy financial sectors put these countries in a sweet spot where housing was attractive for both local and foreign investment. Prices had nowhere to go but up.

The reaction from authorities was also similar in all three countries. Low inflation made them unwilling to raise rates, so they turned to macro-prudential measures aimed at curbing borrowing on real estate. 6 6 Close Australia went so far as to try to cut back on mortgage lending while simultaneously cutting rates. How’s that for contradictory policy? The measures authorities took generally targeted risky loans and securitization. Regional authorities put taxes on international owners to slow foreign speculation. Around 2017, housing prices started to top out in all three countries. Since then, Australia and Sweden have seen year-on-year price declines while price growth in Canada has stalled. Housing construction activity has fallen off in all three countries.

Despite all the talk about housing bubbles we heard several years ago, commentators are pretty quiet now that housing activity is meaningfully slowing. It hasn’t gone as expected. Rapid price increases often end when authorities push back against high debt levels by tightening credit. This reduces new loans and leads to higher payments. Default rates start to go up as fewer people can afford the higher rates. Prices start to fall, which worsens borrowers’ problems. Eventually default rates get so high that they damage banks’ solvency. Then a crisis occurs.

This time tight credit is conspicuously absent, which may be why we haven’t seen the kind of disaster that many had forecast. 7 7 Close Australia hasn’t hiked rates at all, and rates in Sweden are still negative. Only Canada has had what can be described as a hiking cycle and even its rates are probably below neutral. Growth has slowed, but none of the ACS countries is in recession. 8 8 Close Acronyms for random groups of countries are so 2010, but then again so are housing bubbles. Employment remains solid in all three countries. More importantly, their financial systems still appear sound. It may be that this is just the early part of a big unwind of the excesses of the past ten years and more problems will appear later, but that is still speculation.

The macro-prudential steps have certainly played a part in slowing housing markets without significant increases in interest rates, but they don’t fully explain it. Housing markets were hot in all three countries for the better part of a decade. It could be that supply and demand have come into balance naturally. More houses have been built and this has absorbed excess demand, even if mortgages are easy to come by. It could be that many of the folks who wanted to take on debt to finance their homes already have.

If that is the case, then the housing sector should be a drag on these economies, but not an anchor. Other areas may be able to pick up some of the slack. The risk, however, is that weakness in housing leads to subpar consumption. If people have less equity in their houses and they hold large mortgages, they may trim back spending in other areas. Data on consumption in all three countries has been soft this year, which could weigh on growth. Any investors in Australia, Canada, and Sweden should be alert for signs of credit deterioration. These would include rising default rates, elevated monthly debt payments as a percentage of incomes and an increase in the percent of bank’s non-performing loans. So far these look okay, but they would be good leading indicators of future risk. For now, we may be seeing some rare history unfold. Three decade-long housing booms are dying of old age. Let’s hope we don’t have to mourn their passing.

German IFO Business Confidence (Monday), French INSEE Business Confidence (Tuesday)
2018 was a disappointing year for the eurozone economy, as GDP data pointed to weaker growth and surveys showed worsening sentiment across the region. At its meeting in early March, the European Central Bank (ECB) acknowledged these developments, downgrading its growth forecasts and pushing back the projected timeline for monetary policy normalization. Moving forward, market participants will be watching survey data closely for signs that sentiment is starting to turn around. Any improvement in high-profile business confidence surveys to be published this week by the German IFO (Monday) and French INSEE (Tuesday) could provide a boost to the euro and regional equities.

New Zealand Central Bank Meeting (Wednesday)
The RBNZ has signaled that it expects to keep rates unchanged through 2019 and 2020, but this guidance has been called into question in recent months as global growth expectations have declined. At its last meeting, the RBNZ responded to concerns around the global economy by downgrading the expected path for its policy rate as well as the outlook for domestic growth and inflation. While the bank has continued to emphasize strong domestic conditions, such as unemployment near the bank’s perceived full employment level, investors appear to be taking a more pessimistic view. Indeed, New Zealand fixed income markets now price high odds of an interest rate cut within the next year. GDP figures released this week showed the slowest YoY growth in five years, potentially setting the stage for further dovish revisions to RBNZ guidance. If the central bank does indeed signal openness to a rate cut, it could put downward pressure on the New Zealand dollar.

U.K. Brexit (Official Exit Date on Friday)
The U.K. is still scheduled to leave the E.U. at the end of next week, but this deadline will almost certainly be pushed back as the U.K. parliament is running out of time to approve a roadmap for an orderly exit. Indeed, large majorities in parliament have twice rejected the Withdrawal Agreement negotiated between Prime Minister May and E.U. officials. A third vote on the deal is scheduled for next Tuesday, and E.U. officials agreed this week to extend the deadline until May if the vote succeeds. However, as of this writing there is little reason to expect that this third vote will pass, in which case the E.U. has indicated it will only grant a short extension until mid-April. Such a short delay might keep markets on edge due to fears of a chaotic “No Deal” Brexit, although U.K. lawmakers appear keen to avoid this outcome. As of yet, politicians appear unwilling to pursue a longer delay, as this would force the U.K. to participate in E.U. elections scheduled for late May. Heightened volatility in U.K. markets may persist until exit plans become clearer or a longer extension is granted.

This material has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision.


Past performance is not a guarantee of future performance.


This document is not research and should not be treated as research. This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR.


The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein. It should not be assumed that the author or AQR will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only.


The information in this document may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.