Anchor’s coffee table economics note by Casey Delport will be distributed intermittently and is a collection of Casey’s opinions on key economic factors and events shaping markets globally and in South Africa (SA). It is essentially Casey’s thoughts and perspectives on the multiple dynamics at play in the global and local economy.
Executive summary
In this week’s edition, we highlight the following:
- The debate around whether the global economy is currently expecting a housing bubble continues to float along, leaving a raging discourse in its wake amongst economists and experts alike. Whilst substantial arguments can be made for both sides, at the end of the day, the answer may simply depend on the specific market and its unique characteristics.
- The global bond market: An important stalwart of the financial world. Whilst many market participants may not traditionally find bonds particularly interesting (they do not hold the same razzle and excitement as equities and other such financial instruments), the global bond market is an important component of the global financial system, providing a range of benefits to investors, issuers, and the economy as a whole.
- You will pay more for your next Big Mac: Food prices remain upwardly sticky in SA. In another upward surprise, the rate of increase for headline consumer price inflation (CPI) in SA accelerated to 7.1% YoY in March from 7% YoY in February. Stubbornly high food price increases were yet again at the forefront of this latest rise in CPI, as food prices remain upwardly sticky, contributing about one-third to the increase in the headline reading.
Global housing prices: Are we in a bubble?
The debate around whether the global economy expects a housing bubble continues to float along, leaving a raging discourse amongst economists and experts alike. The question remains complex and highly contested regardless of where one’s viewpoint settles. A housing bubble typically occurs when there is a rapid and unsustainable increase in housing prices, fuelled by factors such as low interest rates, easy access to credit, and speculation. When the proverbial bubble bursts, housing prices drop sharply, often leading to financial instability and a recession. During a housing bubble, there is often a disconnect between the actual value of the homes and their prices. This can create a situation where many people purchase homes they cannot afford, or investors purchase properties purely for speculation purposes. It is important to remember that housing bubbles are not a new phenomenon, and they have occurred in various countries and regions around the world throughout history. The most recent and frequently cited example of a housing bubble is the one that happened in the lead-up to the 2008 global financial crisis (GFC) when housing prices in many countries (particularly in the US) rose rapidly before crashing, leading to a severe recession.
As it stands, several arguments suggest we may be in a housing bubble. The first and foremost is the rapid price growth experienced over the last few years. One of the critical indicators of a housing bubble is rapid price growth that outpaces inflation and income growth. In many prominent cities worldwide, including in the US, Canada, Australia, and Europe, housing prices have risen rapidly over the past few years, which some argue is unsustainable. At the end of the day, houses fulfil a rare mix of necessity, utility, and sentimentality and, for many, act as a primary investment to build wealth. Consequently, this element of wealth creation, combined with increasing demand in many countries, is driving housing prices skyward.
If one considers the latest data from the Bank of International Settlements (an international financial institution owned by central banks that aims to foster international monetary and financial cooperation), advanced economies (or rather the most developed countries in the world) have seen the highest increases within their respective markets. However, across all measured countries, the real price of housing has increased nearly 30%, on average, from 2010 to 2022. Iceland is leading the group of 45 countries with increased housing prices over that period, with real, local prices more than doubling since 2010. Countries that have witnessed 85% or higher increases in housing prices include Estonia, New Zealand, Chile, Turkey, Canada, and Luxembourg. As emerging market (EM) economies, Türkiye and Chile are the outliers in this group of mostly advanced economies. Many other EM economies also recorded housing prices increase. In India and Malaysia, housing prices are up by 59%. Likewise, the Philippines (+50%) and Colombia (+40%) also saw real house prices increase faster than the global average. However, it is worth noting that not all countries logged significant housing price increases. Some countries in Europe, including France, Belgium, and Croatia, and in Asia, including China, and Singapore, all saw less than 20% growth in real prices from 2010 to 2022.
Moreover, some countries have bucked the global trend and seen real housing prices fall over the past twelve years. Russia, Greece, and Italy recorded the largest contractions in prices, all with housing price declines of more than 20%. From an economic standpoint, these cases also allow us to see active inflation in a real-world setting. In Russia, for example, despite real housing prices contracting by 33%, nominal prices (which do not account for inflation) are up more than 50%. In SA, real prices have declined by 5%, and nominal prices are up 72% from 2010 to 2022.
Aside from price growth issues, other prominent factors contribute to the argument that we are currently experiencing a housing bubble. These include:
- Easy access to credit: Another factor that can contribute to a housing bubble is easy access to credit. In recent years, interest rates have been at historic lows, and lending standards have been relatively loose, allowing many people to borrow more money to purchase homes than they might have been able to afford otherwise.
- High levels of investor activity: When investors buy up properties purely for speculation and not to use them as primary residences or rentals, this can further inflate prices and create a bubble. In many cities, there has been a surge in investor activity in the housing market, which most economists view as a warning sign.
- Lack of affordability: Housing affordability has become a growing concern in many cities worldwide as prices continue to outpace income growth. This can lead to a situation where many people are priced out of the housing market, ultimately leading to a price correction.
- Reliance on government policies: Government policies such as low interest rates, mortgage incentives, and other housing subsidies can create an artificial demand for housing and contribute to a bubble. When these policies are removed or changed, it can lead to a rapid correction in housing prices.
It is important to note that these factors alone do not necessarily indicate a housing bubble and that many other factors can affect the housing market. Furthermore, the conditions leading up to the 2008 GFC were different from what we see now, so it is important to analyse each market and evaluate its potential risks carefully. As such, several arguments suggest we may not be in a housing bubble. These include:
- Supply and demand dynamics: In many cities, supply and demand dynamics can explain the current surge in housing prices rather than a speculative bubble. For example, in some markets, there is simply not enough housing to meet the demand from buyers, which can push up prices.
- Low interest rates: Low interest rates have been a major factor in the recent surge in housing prices, but they also have other effects on the economy. Low interest rates can stimulate economic growth and make borrowing more affordable for consumers and businesses, which can have positive effects on the overall economy.
- Strong economic fundamentals: Unlike in the lead-up to the 2008 GFC, many economies worldwide are experiencing strong economic fundamentals, including low unemployment rates and GDP growth. This suggests that current housing market conditions may be more sustainable than during the last housing bubble.
- Lack of speculation: While there has been an increase in investor activity in some housing markets, this does not necessarily mean that a housing bubble is forming. Many investors are purchasing properties to use them as rental units rather than for speculative purposes.
- Mortgage lending standards: Mortgage lending standards have been tighter in recent years than they were in the lead-up to the GFC, which has helped to prevent some of the risky lending practices that contributed to the last housing bubble.
The bottom line
From the housing prices of the countries listed above, the data arguably point to the emergence of potential housing bubbles in Iceland, New Zealand, and Canada. However, bubbles are usually only fully identified and measured after they have burst (or have started to). Otherwise, if their inflated values hold through sudden changes in market conditions, they can simply point to more accurately priced demand. It is also important to remember that specific local factors also play a part in many markets. For example, tourism growth and the surge in short-term rentals have also contributed to the housing crisis in Iceland. Meanwhile, in the US, restricted housing supply is one of the factors pushing prices up. All in all, while only one factor in the current successive global interest rate hikes to combat inflation and rising mortgage rates, the housing market remains at the forefront of discussion more so than ever. Overall, whether we are currently in a housing bubble remains a complex and highly debated topic, and at the end of the day, the answer may depend on the specific market and its unique characteristics.
The global bond market: An important stalwart of the financial world
As one of the world’s largest capital markets, debt securities have grown sevenfold over the past 40 years. In fact, in 2022, the global bond market totalled US$133trn. Government and corporate debt sales across major economies and EMs have been fuelling this impressive growth. In terms of even more impressive statistics, over the past three years, China’s bond market has grown by 13% p.a. Unsurprisingly, you would be hard-pressed to argue against the critical role the global bond market plays in the global financial system. First, the global bond market is one of the largest financial markets in the world, making it an important source of capital for governments, corporations, and other entities across the globe. As such, bonds are an essential source of financing for governments, corporations, and other entities. These entities can raise funds to finance important projects and initiatives by issuing bonds. Bonds diversify investors’ portfolios, as they typically have lower volatility and lower correlation with stocks. This can help to reduce overall portfolio risk.
Moreover, bonds generally provide investors with a predictable income stream through regular interest payments. This can be especially important for investors looking for a stable source of income. Furthermore, bonds are highly liquid, meaning they can be easily bought and sold. This makes it easy for investors to enter and exit their positions quickly. Furthermore, as an often underappreciated factor, central banks across the globe use the bond market to help implement monetary policy. By buying and selling bonds, central banks can influence interest rates and the money supply to achieve their specific objectives. Lastly, the bond market is a benchmark for other financial instruments, including mortgages, loans, and other debt securities. Overall, whilst many market participants may not traditionally find bonds particularly interesting (they do not hold the same razzle and excitement as equities and other such financial instruments), the global bond market is an essential component of the global financial system, providing a range of benefits to investors, issuers, and the economy as a whole.
Considering the world’s top bond markets, the US has the largest bond market globally – valued at over US$51trn. Government bonds comprised most of the US debt market, with over US$26trn in securities outstanding. In 2022, the Federal government paid US$534bn in interest on this debt. China is second, at 16% (US$20.9trn) of the global total. Local commercial banks hold the greatest share of their outstanding bonds, while foreign ownership remains relatively low. Foreign interest in China’s bonds slowed in 2022 amid geopolitical tensions in Ukraine and lower yields. Japan comes in third at US$11trn, with its central bank owning a massive share of its government bonds. Central bank ownership hit a record 50% as it tweaked its yield curve control policy that was introduced in 2016.
The policy was designed to help boost inflation and prevent interest rates from falling. However, as inflation started to rise in 2022 and bond investors began selling, it had to increase its yield to spur demand and liquidity. Consequently, the adjustment sent shockwaves through financial markets. In Europe, France is home to the largest bond market at US$4.4trn in total debt, surpassing the UK by roughly US$150bn. Closer to home, the SA bond market is one of the largest in EMs and is also relatively well-developed compared to other EMs, with a high degree of liquidity and transparency. The market is open to foreign and domestic investors. There is a diverse range of issuers, including the government, state-owned enterprises (albeit not the most popular of issuers at the moment, unsurprisingly so) and corporations.
The bottom line
As interest rates have risen sharply since 2022, the price of bonds has been pushed down, given their inverse relationship. This has raised questions about what type of bonds banks hold. Moreover, as higher rates reverberate across the banking system and the broader economy, it may expose further strains on global bond markets, which have expanded rapidly in an era of dovish monetary policy and ultra-low interest rates. However, the global bond market is an essential component of the global financial system, providing a range of benefits to investors, issuers, and the economy as a whole. For individual investors, in particular, bonds remain an important part of any portfolio given their range of benefits, such as diversification, fixed income, lower risk, capital preservation, liquidity, and the ability to support important financing initiatives.
You will pay more for your next Big Mac: Food prices remain upwardly sticky in SA
In another upward surprise, the rate of increase for SA’s March headline CPI accelerated to 7.1% YoY from 7% YoY in February. Stubbornly high food price increases were yet again at the forefront of this latest increase, remaining upwardly sticky and contributing about one-third of the increase in the headline reading. Price growth in the food subcomponent rose at the quickest pace in fourteen years (+14.4% YoY), led by marked price increases for milk, eggs and cheese, and fruit and vegetables. However, we believe that food prices will remain a significant source of uncertainty in the coming months, given the time-varying nature of leads and lags from lower crop prices (for example, white maize futures are down about 35% from their peaks in October 2022) to shelf prices and the increasingly hard-to-quantify effects of loadshedding. Furthermore, there is early evidence of mounting El Nino risks, which could generate fresh upside food pressures in 2024 if this climatic phenomenon materialises strongly towards the end of the year. Positively, the transport subcomponent, where the rate of increase slowed to 8.9% YoY amid softer (annual) price increases in fuel, helped to keep the overall rise in headline CPI more muted.
Furthermore, quarterly rental inflation remained subdued, indicating that demand-pull inflation remains contained. Moreover, it is worth noting that core inflation remained stable at 5.2%, in line with market expectations. Overall, after scratching through the numbers, it appears that about half of the rise in domestic food prices is due to rand weakness, and the rest to rising domestic costs – particularly loadshedding and other input costs to the agriculture production process, including transport costs. These costs, in particular, are tricky to quantify and consequently forecast. With core goods and food higher in the near term, we turn more towards the SA Reserve Bank’s (SARB’s) forecasts that headline inflation for 2023 will average around 6% this year. On a monthly basis, we will see the headline number duck back under the upper end of the target range, however the exact timing remains the big question.
The bottom line
Headline CPI inflation should ease in the coming months, despite this latest upside surprise. Even after the rise in Brent crude oil prices following OPEC’s announcement on cutting supply, base effects should see fuel inflation falling further in the months ahead, carrying a strong disinflationary effect. Moreover, as we noted above, food inflation should start to moderate especially given the strong base effects. That being said, with ongoing bouts of loadshedding and inflation expectations drifting higher, uncertainty around the path of CPI inflation is higher than usual. While the in-target medium-term inflation forecasts, high and restrictive forward-looking real rates, weak demand-pull inflation and even the SARB’s Quarterly Projection Model (QPM) support the case for the central bank not tightening rates further, this latest inflation overshoot will fuel the SARB’s concern about the perpetual upward inflation forecast revisions, even though they are short term in nature and with the medium-term trajectory continuing to drift around the mid-point of the SARB’s target range. Therefore, despite this latest inflation data strongly implying that demand-pull inflation pressure remains contained, it increases the likelihood of further tightening. Concerningly, the latest data from the National Credit Regulator show early signs of mounting consumer debt distress in 4Q22, with a noticeable rise in fresh overdues on consumer loan contracts, a record number of credit applications, an elevated rejection rate and a decline in the value of credit granted after adjusting for seasonal factors. Moreover, after the SARB’s 375 bps of rate hikes since late 2021, we are not surprised to see evidence that consumers are increasingly struggling to repay debt on time. Unfortunately, we expect these trends to have worsened in 1Q23.
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