Tuesday, August 24, 2010

Line Ball Downunder

For those of you that have been following international politics lately, Australia has managed to follow the UK's lead in getting itself into the one big mess possible in a Westminster system: a hung parliament. There are 150 seats in the House of Representatives in what the locals commonly refer to as "God's Country" and in order to form government you need 76 of them. At this point in time the historically teamster-oriented Labor Party has about 72 and the paradoxically named conservative Liberal-National Coalition (a weird amalgam of libertarians, small l liberals, the religious right and agrarian socialists) is on 70 with the balance of the seats held by the "land rights and emissions trading for gay whales" Greens (1) and a bunch of other guys - yes, they are all guys. Let the horse trading begin......

TMM is not universally of the view that a hung parliament or coalition governments are a bad outcome - the UK appears to have got through a tough and credible budget with an odd coupling of Liberal Democrats and Conservatives and for all intensive purposes the UK is much less of a train wreck than any of the members of TMM would have thought. Australia, however, is a different kettle of fish. Having people like Bob Katter holding the balance of power does not bode for political stability of any kind, just look at this election ad - and no, this is not a joke:

That, combined with a predominantly Green and extreme left Senate does not bode for getting a whole lot done politically.

This might not be that much of an issue at all if it weren't for the unfortunate fact that a lot of what has made Australia a braindead trade for the last 18 months appears to be unwinding. Chinese commodity demand is coming off and all indications point to China being happy to cool off its property sector as much as it can without bankrupting the developers and the cement, steel and aluminum companies that rely on them - July bounce notwithstanding, the economics departments of most banks have been left waiting at the station for a China stimulus package that hasn't come. This does not bode well for a country whose core exports are iron ore, coal, and base metals. To add to the problem, Australia's bizarrely overvalued property markets are getting some attention again from the likes of Morgan Stanley who are calling a top in Australian real estate. Practices such as negative gearing are getting the attention of treasury officials as a good way to raise revenue and take the froth out of the market - pity the banks aren't even close to ready to take the kind of hit to their loan books an explosive real estate unwind would entail.

Which leads TMM to think that maybe the short AUD, short Aussie equities trade is an idea whose time has come. On almost any basis you care to mention - PPP, FEER, DEER, charts, you name it - the Aussie isn't exactly cheap and is easy to sell above 90 cents. On the equities side a cursory glance at the ASX will leave you with four banks leveraged to real estate and with pending offshore funding issues, a few insurers and a shedload of mining companies that are entirely leveraged to China. If we really are going all deflationary, why has this stuff held up? TMM could yet be proven wrong by global stimulus but it may not be long before Aussies are thinking of happier times.


Leftback said...

USDJPY below 84... and nobody going long the AUDJPY until the election is resolved?

Richard said...

Yeah, with 101% of my net worth in Australian dollars, I'm a little worried. On the plus side, bank term deposits yield over 6%, and would you really buy Yen, Euro or US dollars instead?

Australia is also a large gold exporter, and it has been demonstrated that the government will prop up the property bubble by any means necessary. They don't yet have the crippling debt that would prevent them trying. The housing bubble will go down eventually though, and I expect high unemployment at some point due to the inflexible labour market. Even during these "good times" they can't get unemployment below 5%, while inflation sits around 3%.

Richard said...

I trust the Australian banks until 12 October 2011, when the government guarantee on deposits expires. It will be interesting to see if it's replaced by some new scheme - the big four banks have an implicit bailout guarantee in any case.

Regarding the labour market, correct me if I'm wrong, but I believe there's a centrally mandated pay scale for every occupation in Australia, and it's illegal for an employer to pay less.

da said...

Richard, with all due respect the Government has withdrawn their guarantee http://www.dynamicbusiness.com.au/articles/articles-news/government-wholesale-bank-deposit-guarantee-1287.html

As to housing, the simple fact of the matter is that the tax system supports negative gearing and allows interest deductions and other costs in maintaining a rental investment to be set off against income. This has huge benefits were taxpayers perceive that they are better off with this type of asset. The problem is those investors who did not acquire housing in an undesirable socio-economic neighbourhood. The need for low cost low rentals is high. The middle and higher income properties have been effected.
Now labour ... please note that we are short skilled labour and have been for some time. The mining industry infrastructure projects has reached its peak, however their need for skilled labour increases.
It is this mining resource super tax that will gradually have an impact and force companies offshore... regretfully they do not have a banking super profits tax!

da said...

"Regarding the labour market, correct me if I'm wrong, but I believe there's a centrally mandated pay scale for every occupation in Australia, and it's illegal for an employer to pay less."

Yes we have the minimum wage and a minimum hours worked in force and draconian laws for any employer, i.e. cannot be judge and jury, cannot dismiss for theft, being intoxicated, a danger to others or taking too many sick days. Teenagers cannot be employed by fast food outlets for a minimum of one hour after school... it goes on but these are left wing imposts on the legislation that I fear will not be changed. God bless the unions and the factional parties they support!

da said...

On Oz, I personally think that we down under are in far better shape than the rest of the world, even after our government blunders. One must realise that the Eurozone countries debts to GDP is obviously, in reality, rather higher than is being admitted publicly (or measured by Eurostat). The US individual states are all bankrupt and the USA / Japan debt levels are enormous.
Looking at NZ their unemployment rates are increasing and they are again departing in droves to Australia.
So where to from here?
We may see the same cycles that led to money moving through to Asia with the 1998 pop in Asian markets. All capital flows will seek a home, with the highest profits and political stability.
Australia with its MRRT and CGT is definitely not one of them. The Labor Government has shown its true colours by the MRRT. Marxism is alive and kicking, we need a stable Government and lower taxes and that we will not have in the short term.
Look at history in that Labor f#@ks up and Liberal fixes up.
I just love history do I not!

Richard said...

da said...

Richard, with all due respect the Government has withdrawn their guarantee

Yeah, well they withdrew the wholesale guarantee, which is obviously going to be the main point of interest to this blog. Foreign investors are now happy to fund the property bubble without any explicit government guarantee, oddly enough. I wonder if the banks hedge their foreign exchange risk.

However I was referring to the retail deposit guarantee, which remains in place.

Richard said...

The Labor Government has been just terrible. I haven't seen anything like it (in a county of residence) since the 1970s.

Nic said...

Great post!

I don't much like the CAD or the TSX right now either.
Take a look at how much debt the province of Ontario has compared to say ... California or Greece. The new Harmonised sales tax has added around $500 per household per annum. Right now it reminds me of the US a couple of years ago, restaurants, stores, malls, parking lots not nearly as busy. House sales in Toronto have stalled badly (much more than the usual summer doldrums). I have a friend who owns 5 gas stations. 6 months ago someone paying by credit card for gas was rare but lately he says CC use has exploded.

Nic said...

Spooky BAC story

Richard said...

That Kylie Minogue video is blocked in Australia :(

Rajat said...

These metrics used to show that Australian housing is overpriced don't amount to much. If price-rental or price-income ratios were so important, why has residential property in the US fallen by more than in the UK? Australia has been experiencing 2% pa population growth and combined with restricted land release and planning policies, prices have naturally risen. Discounted variable home loan rates (ie for good customers) only went down to 5% in early 2009 for a few months and they are now back at 6.6%; there is a lot of scope for them to fall further and longer if there is a(nother) global recession. When that happens, all those negatively-geared landlords will no longer be negatively geared and Minack's feared property fire-sale by investors will evaporate. Finally, lending standards in Australia never fell to the levels in the US and UK. I was shocked to find when I was in London back in 2003 that one could get a home loan without proof of income. Mainstream banks don't do this in Oz.

Nic said...

Another rumor of a fund blow up in Macro-land this morning. Liquidation cross currents in commodities.

Leftback said...

2s10s broke below 200 bps... 195 bps for a minute there, after the latest economic data turd in the US this morning.

LB's main error these last few weeks (and there have been so many) has been in under-estimating the size of the squeeze that would be induced by the Fed's POMO program, as some of the InvestTools™ who had crowded into the Steepener Theatre finally smelled smoke... it is clear now that the size of this move in yields has also been exaggerated by the unwinding of several dying macro funds.

Again it is hard to believe that the FED wanted to cause this much chaos, or to bring rates this low. The Law of Unintended Consequences at work once more. The FED's intention was to drive investors out along the risk curve into higher yielding securities, but by blowing up these fund positions so abruptly in a quiet August market they have achieved almost the exact opposite. What is it about August? Didn't LTCM blow up in August?

Nemo Incognito said...

LB - Amaranth too in 06. I remember once sitting bored as all hell in August and seeing a bajillion standard deviation moves in nat gas spreads. Oh, and that whole quant equities thing in 07, commods in 08.... yeah come to think of it August is hardly the dull summer month it should be.

Question is - WTF now? This bond move has a some serious momentum but where next? With housing so smoked I can see the bull case in 2 yr and 5 yr but 30? Come on....

Leftback said...

Nemo - Agreed on the 30y, which LB has now sold. I am on the fence about the ever-popular "flation" question. We have gone from people screaming hyperinflation last summer to a sky is falling deflation theme this week.

What if we just for a moment ignore all the manic depressives around us and imagine that we might have a 0.5-1.5% growth rate, and therefore a low but stable rate of inflation? That would be an ideal environment for dividend-paying stocks and high yield bonds.

All LB can see today is people buying low yielding 2y Treasuries into a parabolic move, while dividend stocks yielding 5-10% are falling. Also, if this FED move was intended to backstop the corporate credit market, why wouldn't you move out there instead of locking in low returns (if you hold to maturity) or exposing yourself to losses (in funds, if fulminant deflation doesn't arrive, or if, God forbid we have 2-3% inflation)?

LB is as bearish as the next bear, but sometimes one has to balance one's cautious outlook....

FX said...

Knock it off you UK lads, your not going to make tommorrow that easy are you?


Nic said...

Cocoa -7.8% MoM.

Sooo happy I didn't try and corner the market this month ;)

Leftback said...

GDP 1.6%.
WORLD NOT ENDING! Imagine one's surprise.....

It was a bit bizarre to see well-known bondophobes touting the virtues of Treasuries this week.

Sometimes when all the shorts have covered, only the unwary are left to buy.

Leftback said...

The FED doesn't control everything, but they do have some control over Treasuries. The FED probably doesn't want to see this week's massive volatility in bonds. LB believes that they will target a narrow range and try to hold the 10y here, between say 2.50% and 2.75%, 30y between 3.50% and 3.75%. That enables a lot of mortgage refi to occur over the winter, and if sellers adjust their prices we may even see some home buyers emerge in the spring.

Option ARM resets in 2011, so they will probably want to pin rates here until we are through that period, in order not to trigger another disaster for the big banks. Letting rates fall lower than 2.50% on the 10y seems like diminishing returns, and they need to keep the yield curve steep to some degree until and unless there is some degree of recovery in employment, which seems distant at present.

So, a few predictions. A steadier bond market, low rates for an extended period, and an extended period of high unemployment. A slightly lower dollar and a low rate of inflation. This could last a year, five, or ten.... of course, if any serious austerity programs are implemented in the US or Europe (other than minnows like Greece and Ireland) or if China blows up, then all bets are off.

So where are the flaws in this argument?

wcw said...

> low rates for an extended period, and an extended period of high unemployment... and a low rate of inflation.

This has been the obvious bet for some time, hasn't it?

> A slightly lower dollar

Why does that hurt the USD?

> if any serious austerity programs are implemented

Even a GOP Congress wouldn't be that dumb, I hope.

> if China blows up

This is my big worry. Residence prices in China strike me as deeply addlepated, and that does not calm.

FX said...

LB, the FED has'nt changed its tune of late , the risk bet in USA is now in a state of flux until the negative data (worse to come) rolls in and rolls off, in that order,personally I don't see another reflation trade of a quarter of the magnitude of 09,even if the FED jumped out of the box with a full size QE2, while that happens, yeah, we are left in the hands of exogenous forces.

Geez, I was looking for some follow thru from our STFU indicator from late last week,did you see that spike,thats going to be our proud sponsor for our day out at Ascot.(exogenous force level 1)

Nemo Incognito said...

Yeah viz cocoa folks there is one thing I have to say and that is:

11th Commandment: Thou shalt not get caught. If thou dost, thou shalt be castrated by the blazing scimitar of your regulator or squeezed in the vice like grip of your competitors positions.

Richard said...

The Aussie dollar is back over 0.90, so there is your easy short if you want to take it.

Polemic said...

Well, a nice US market bounce on Friday with some M+A news thrown in Its no wonder AUS is up. But Bank Hol in London, end of August, all the Kevs and Trevs coming back from hol (me included) and Aud over 0.9000? Yes .. I 'll take that short ready for a Sept kick off, but will probably do half and wait for a Sept 1st starting gun to get some of the month end madness out of the way before doing the other half. Irelandv stress to come this week then Spain to follow. Cant think they will leave the Aus unscathed. Current yields and metal mania are already in the price.

Looking forward to the end of the summer interlude and getting on with the bigger picture..


Nic said...

Polemic did you see this?:

Rumor PBoC Governor Zhou Xiaochuan Has Defected From China After Suffering Half A Trillion In UST-Related Losses

Polemic said...

No Nic I hadn't thanks. I was too busy watching a bank holiday movie which ends with the big bully baddy getting his comeuppance at the hands of the poor weedy kids..

You sure that story you posted isn't just part of the same script?

430 bill Loss on treasuries ? Maybe they actually lost the original bonds down the back of the sofa. Going to be lost of conspiracy theories running with this one .. Cue the bonds/jap diplomats/switzerland car boot story ..

Nic said...

Ha I thought about that but
are a pretty legit organisation.
Although the story is a bit thin on substance, still the most interesting news of the day.

Leftback said...

ZHOU isn't the Black Swan but may be a charred Peking Duck.

Nemo Incognito said...

How the F do you lose money on treasuries in this market????? Currently short a decent clip of HSCEI so if comes out and says "its all going to hell" that's ok by me.