Daily Commentary BY THE CURVE TEAM –

Alarm Bells Ringing

1st of June, 2017

It has been just over a week since S&P lowered the credit ratings of 23 of Australia’s banking institutions and they are once again in the headlines. In an interview overnight, chief ratings officer Moritz Kraemer was interviewed and turned his focus towards Australia’s AAA rating. 

Unfortunately there was little in the way of positives to take away from the interview. First he pointed out where Australia differs from other AAA sovereigns, saying “among the AAA rated — the top notch rated sovereigns, of which there are only 12 left in the world — Australia is the only country with a large external debt.”

Leaving little doubt about what that means in the broader scheme of things, he quickly added that “actually I will go further and say it’s the only AAA sovereign which has any net external debt. This is a clear outlier and a weakness of the credit profile of the country.”

This external debt problem is a result of a banking sector which has long relied on overseas funding to meet the ever growing local demand for debt. It is also why the government is under scrutiny regarding its budget deficit in order to reduce the external debt burden to the rest of the globe.

Discussions then turned to the hot topic of the moment, Australia’s ballooning household debt and soaring house prices. Kraemer once again did not mince his words, saying that “the longer this goes on the higher the risk of a disorderly adjustment.”

At present he indicated that it’s not fait accompli but the risks are rising, saying that “right now I think it’s still very much within control of the authorities and the banks to generate the soft landing but there are so many examples of asset bubbles and usually it doesn’t end in a gradual process.”

Speaking of Australia’s authorities that Kraemer mentioned, Wayne Byers appears before a parliamentary committee overnight and was comprehensively grilled for more than two and a half hours by a number of senators. 

After deflecting the barrage of questioning for most of the session he eventually cracked. After being pushed on what point housing debt levels trigger alarm bells, Byers succumbed, saying “I’d say they’re [alarm bells] going off softly. That’s why we’ve been intervening in the sense that …” before he was cut off by further questioning.

With interest rates at record lows and the government largely having their hands tied, what will come to the economy’s rescue if we get a disorderly adjustment in the housing market?

David Flanagan

Director - Interest Rate Markets