Speakers: Paul Diggle, Adam Slater

Paul  00:06

Hello and welcome to macro bytes economics and politics podcast from Aberdeen. My name is Paul Diggle Deputy Chief Economist at Aberdeen, and today we are talking about housing markets. Is a global housing market downturn developing, how severe might it be, and which countries and economies could perform better or worse during a housing correction. So it's a very important topic. It's one that people are interested in both personally and also because it's a key driver of the broader macro economy. And I'm delighted to be joined by Adam Slater, lead economist at Oxford Economics, who are a leading macro economic research consultancy. Adam has recently written a series of very insightful research pieces on global housing market dynamics is someone I've spoken to in the past for insights and direction on the course of the global economy. So I'm very much looking forward to this conversation. Adam, welcome to macro bites. And let me start by asking you the the 10,000 foot kind of overview question of the state of housing markets, what are house prices, housing market transaction new starts doing in the major economies, what trends can we put out?

Adam  01:26

Okay, well, we see a general pattern of housing markets moving from expansion to contraction, prices are falling in most of the major economies in the US, Germany, the UK, China. Also in places like Australia, Canada, New Zealand, Sweden. So quite widespread price falls now. The one exception among the major economies present is Japan. In terms of transactions, yes, we also see a sharp slowdown there. Quite strikingly, in the US mortgage applications have roughly halved from their peak and are now close to the lows we saw after the global financial crisis. And in the UK mortgage approvals have dropped sharply as well in recent months now below pre pandemic levels. And in terms of construction, well, again, the US data has deteriorated a lot in recent months, down around 25%. In China, we got an even larger decline more than 50% from the peak. And we can also see quite a big decline to places like Sweden. It's not a universal pattern, though, yet. So if we look at, for example, Canada, where prices have actually dropped quite rapidly in recent months, there hasn't been a decisive downturn in the housing starts yet and nor has there been in the UK. So generally, it's a picture of of decline in most of the major economies, but with with a few variations.

Paul 02:45

Interesting, and we're gonna get into the drivers of that that variation that cross country difference. Is it the same story everywhere of those drivers being moderating broader economic growth, the real income squeeze higher mortgage rates? Or are there idiosyncratic stories as well that explain why some economies housing markets are doing better or worse?

Adam  03:10

I think for most of the advanced economies, the basic drivers are similar. We've got sharply rising interest rates, mortgage rates, we use real incomes, weaker economic growth. The extent to which these factors are operating across economies, it does vary. So rates are rising much faster. In some places. real income squeezes are larger in some places to, for example, places where we've had very big rises in energy prices. And some markets are more sensitive to the changing conditions than others. And this reflects facts like how much prices ran up before the downturn started. The degree of overvaluation structure of mortgage debt floating versus fixed. So, to give an example, markets like Canada and New Zealand appear to have been especially vulnerable and this is visible in recent price trends. Whereas we have some markets which have been fairly quiet in terms of price rises activity in recent years, like Italy, Japan, and there there are a few signs of any downturn so far. And in terms of overbuilding, well, this was definitely an issue the last time around in the wake of the global financial crisis in several markets, probably most notably, Ireland and Spain. On this area, were perhaps cautiously optimistic because there hasn't been a very large boom in house building in recent years in most of the major economies. China is an obvious exception here, of course. And we point to a few other markets where there has been quite a strong boom Canada, Finland, Taiwan, New Zealand, and to a lesser extent, Germany.

Paul  04:44

So people's reference point when they're thinking about housing downturns is of course, naturally the financial crisis and that experienced through 2007 2008. Can you give us a sense of where there were overvaluation problems? This time around where there was overbuilding. How did it compare to those excesses on the eve of the financial crisis where we are stretched in the likes of New Zealand and Canada and valuations in China on oversupply? As we were saying the US or Ireland in 2007 2008?

Adam  05:18

I think in terms of valuations, the worst kinds of valuations, we're seeing all the highest level of overvaluation we're seeing in our very long term model that we use is valuations of about around about 15% or so perhaps up to 20% in some of the the frothiest markets. That is broadly similar to what we saw, ahead of the global financial crisis, but not necessarily in the same economies. So for example, valuations in the US were probably higher that time around. So it does vary in terms of over building housing construction. Well, we've got quite a mixed picture, I think, when you got places like Ireland, where, for example, you had extreme levels of overbuilding, if we go back to the global financial crisis, but after a dramatic decline, things never ever recovered. And house building levels now, still extremely low by historical standards. Whereas we've got places like Canada where house building has been fairly hot over the last few years, so that the the share of housing investment in GDP in Canada is quite high around 9%. And that is higher than the global financial crisis peak, quite clearly higher, and also quite significantly higher than there's a rolling 10 year average as well. So it varies quite a lot. In some cases, we're seeing places where levels of risk on these key indicators are similar to what we saw before the GFC. And other places, it's quite different. There's been something of a rotation because some of the markets that looked riskiest, that time, like the US looked quite a lot less risky on some of these metrics. And this time around, that's also true to some extent for the UK.

Paul  07:04

And then they're rising mortgage rates you mentioned as a course are absolutely crucial driver of why some housing markets are under pressure. But it's not only the size of the typical increase in mortgage rate that matters, of course, it's the degree to which it passed on to borrowers. So the share of floating versus fixed rate mortgages, matters, the typical maturity of a fixed rate, mortgage matters and all that, of course, governed by the structure of individual countries mortgage markets, can you talk throughout them some of those cross country differences? Where are mortgage borrowers particularly sensitive to changes in mortgage rates? And where are they perhaps more more insulated?

Adam  07:50

Sure, mortgage market structures vary a great deal across the major economies. So you have markets like the US where the bulk of lending is very long term fixed rates, and often 30 years. And places like Germany, France, which are all dominated by fixed rate lending, with lengthy terms, then you have places like Australia, Spain, Sweden, Korea, Norway, where a lot of lending is floating rate. And then you've got sort of intermediate cases, I suppose, like the UK, New Zealand, Canada, where fixed rate lending is the largest part of lending. But the length of the fixes is typically not very long, maybe two to five years. And that means, of course, that in any given year, quite a large fraction of the outstanding fixed rate loans need to be refinanced, which in the current environment would mean substantially higher yields than they were taken out at. And I think it's actually quite important to, to drill down to the detail here, because in places like New Zealand, for example, around 40% of fixed rate deals are due to mature in 12 months. So it's actually much more of a floating rate market than it necessarily appears. Just floating rate share data, if you'd like

Paul  08:57

So have those shares of floating versus fixed or the maturity of fixed rate mortgages changed over time, for example, had the long period of very low interest rates post financial crisis push people into different mortgage products that might have been typical of an economy?

Adam  09:17

I think it varies a lot across markets. One very notable thing that we have found in the data is that in Canada, there's been quite a notable shift towards floating rate lending in the last couple of years. And this is an additional risk factor for what's already a risky market because obviously people have been buying, taking out floating rate debt quite close to the top of the market when prices would have been elevated as well. We also see some evidence that floating rate borrowing or borrowing are very short term fixes on the up in one or two other markets like the Netherlands as well. So you do see shifts towards floating rate in some places. I mean, ino ther places floating rate has become much less popular. For example, in the United States Adjustable Rate Mortgages they're called they were quite popular in the period just before the global financial crisis, but they've dropped in popularity very substantially since then not such a big issue there anymore. So it varies quite a lot across the markets.

Paul  10:17

Of course the structure of the mortgage market has very long term drivers behind it as well, you know, the US's prevalence of very long 30 or 15 year fixes is all to do with the the history of Fannie Mae and Freddie Mac and how mortgage financing works. So that kind of deeper history of of mortgage market structures comes in here as well, doesn't it?

Adam  10:40

Yeah, absolutely. There are. There are long term structural factors which determine not just the way that mortgages are structured in terms of their interest rate, but also their maturity, also how much debt people take on things like mortgage interest tax relief, for our our importance on places to where you have that in existence, like Denmark, for example, people have a tendency to take on bigger mortgages than they will do elsewhere, because it's tax efficient to do so. Especially in a country where where marginal income tax rates are quite high as well. So these kinds of factors are important in determining structural features, levels, levels of debt, quite often,

Paul  11:16

well, let's talk about levels of debt. And kind of the ratios of typical borrowing to income or the whole economy, housing, leveraged income, these big macro variables are born part of what economists care about, are there housing markets, where, where housing debt income is notably high, and therefore perhaps vulnerable, or still quite low. And therefore, the housing market might be more insulated.

Adam  11:44

There are I mean, it varies a lot. As I said, I mean, you've got quite high debt levels in places like the Netherlands, Denmark, Australia, Canada, New Norway, New Zealand, typically over 100% of income, and in some cases, approaching 200%. And then you got places where it's much lower, it's 60 to 70%, in places like Germany, Spain, Japan, even the US Then, and only 33% in Italy, where there's very different history with people not telling them to take out mortgages to buy homes, but taking money from family members or whatever instead, in terms of what it looks like, versus the GFC. Well, as I mentioned earlier there has been a bit of a rotation. Yeah, there are markets like Sweden, Canada, Norway, Australia, where debt levels are higher now than they were before the GFC, where, where leverage was actually added after the GFC. Whereas in places like the US, the UK, Spain, Holland, there were quite big efforts by households to D leverage after the GFC. So in those cases, you've got debt levels. Well, in some cases, they're still high are actually generally quite a lot lower than they were before the GFC. So you've had this rotation of risk out of some of the riskiest markets that were there, say 2006 2007 and towards some other markets

Paul  12:55

And is that is that rotation because of the chastening experience of the financial crisis? So there was a long deleveraging after that, because households had reassessed their desire for mortgage debt. But perhaps those that were relatively more unscathed by the GFC, then continued to build Is that Is that why you see those kind of shifts in the pattern?

Adam  13:17

Well, that's certainly part of the story. Some households chastened. Some of the reduction in mortgage debt in the US, for example, is actually due to debt being written off, defaulted debt, quite significant in some places. What happened with the other markets, I think, is that they got away without having a very big initial downturn in the GFC. And as global interest rates dropped very sharply to low levels, that actually encouraged people to go out and borrow more. And so they re inflated the the bubbles quite quickly, in places like Australia, and Canada, for example. So you had these sort of two things operating in tandem, those markets, which escaped an initial very bad downturn actually ended up being boosted by the GFC, because of its impact on global interest rates, whereas those that didn't escape, you've had this kind of long lasting deleveraging effect, which is, which has gone on really right until the last few years,

Paul  14:08

set them they're very clear picture of cross country differentiation driven by differences in in debt levels, mortgage market structure, the extent of broader macro headwinds to the housing market, that's the clear message. And how do you pull that together then into a consistent framework, that might give you a sort of a bit of a rank ordering of where you would expect a housing downturn to be more and then less severe? How do we kind of bring that all together?

Adam  14:46

Well, we've had a couple of goes modelling things at Oxford Economics in this area. One thing we've done is ranked economies across a range of risk factors. Things like recent price changes the East to extreme, see rates, increasing valuations, floating rate shares and debt and mortgage debt levels, and we rank the economies on each of those and then take an average rank. And that sort of exercise brings. countries like Canada, New Zealand, and Netherlands, Australia, US to the top of the risk table. And places like Japan, France, Italy, are at the bottom. Another thing we've done is we've looked at some drivers of past house housing downturns across a range of economies and worked out what the key driving variables are, in those cases, a different kind of modelling. And what we found from that was that one factor, which is very important, is what happens to unemployment. rising unemployment can have a very big impact on house prices by creating a lot of forced sales and forced sales themselves tend to have a disproportionately negative impact on housing markets, because they're often executed at rather low prices. So higher unemployment, higher forced sales means means a bigger risk level. So one of the key things to watch, I think, over the next 12 months, really is just having an increase in unemployment we will have across the major economies. And there's some reasons for for optimism in that area, in the sense that we seem to have very tight labour markets now. So it could be that there won't be quite as big a rise in unemployment, as there was in some previous recessions. In that case, we might get a milder outcome for housing markets too, because as we mentioned, this is quite a key variable detail.

Paul  16:49

And housing markets, of course, are not just driven by the macro economy, they are in turn, an absolutely crucial driver of the macro economy. So why don't, Adam, you talk us through the transmission channels through which that operates, how does housing drive the broader macro?

Adam  17:13

Okay, well, I think there are probably five or six key channels for this pure wealth effects, which is just people feeling poorer, because their house price has gone down, then spending less, what you might call collateralization effect, people stop borrowing against the increased value of their homes. So there's less equity withdrawal. There's lower housing transactions also mean less consumer spending on things that are associated with House purchase. So yeah, sure, fittings, it's all housing construction, what we find is that price downturns tend to be associated with large drops in housing investment as well. And that directly affects GDP. And finally, I think, financial feedbacks. So rising non performing housing debt, always defaults, damage bank balance sheets of banks then react by reducing lending, more generally slowing the economy another way. So all these factors are in the mix.

Paul  18:08

And is is your assessment that that financial channel, the latest one, through bank balance sheets was of course was absolutely crucial feedback loop almost doom loop during the financial crisis. Is that one as vulnerable now as it was then or is your assessment that banks have improved the quality of their loan books, you know, done less in the way of financial engineering that that, you know, it's still a channel, but it's not the powerful amplifier that it has been in in the financial crisis.

Adam  18:42

It looks like both on things like capitalization, the banks are in a better position than they were the global financial crisis, obviously, we had quite a lot of regulatory reform, in the wake of that banks were obliged to increase capital levels quite substantially. So on that basis, banks look less vulnerable, and so we'd get less of a financial feedback effect. Also, as I mentioned, before, if we get a less pronounced rising unemployment, that probably means fewer mortgage defaults to level, less danger of this particular channel operating. Having said that, what we can see from Central Bank surveys of bank credit standards, is that banks, especially European banks, are already starting to tighten lending for mortgages quite sharply in response to the external factors that they can see operating already. And this obviously, will tend to worsen the housing downturn by stymieing lending to the sector. So we're not out of the woods entirely on this it may be the banks are just being very pre emptive here, getting ahead of the game. Or it may be that they end up overreacting and actually wasn't.

Paul  19:51

And in thinking about the wealth effect channel is added we have obviously seen some degree of fall in house prices already as you described. The Start, is there signs and things like consumer confidence surveys that that wealth effect channel is operating already, or consumer

Adam  20:09

confidence surveys certainly look pretty grim in the main, whether or not that's to do with housing is another question. Because obviously they take into account rather a lot of things. And probably the primary driver of those just now is the cost of living squeezed connected to energy prices and so on. So I think it will be maybe a little premature to, to link the two at this point. But and also the, in most places, the drop in house prices we've seen so far isn't isn't a very big one. We're at the very start of this process. So it will be surprising if that was a real big impact quite yet. That doesn't mean it won't have in due course, of course.

Paul  20:48

And then perhaps as a final question, Adam is how, how big a macro headwind does it all add up to so there are multiple transmission channels, as you've described? I know you've done some modelling work of what plausible housing downturns with this regional differentiation, mean for macroeconomic aggregates things like GDP? What sort of size of additional drag on the economy are we talking about?

Adam  21:18

Well, obviously, we've got a certain amount of data in our baseline forecast. Now. The modelling you refer to is something which involved is shocking housing markets and residential investment by more than we had in the baseline. And what we find is that you get quite a big impact, actually, if you do this. So if you cut house prices by a further 10%, on top of what we have in the baseline globally, then global GDP is reduced by about 0.2%. In a year or so, where we actually get the really chunky effects, though, are if we start to layer on some other impacts, so if we drop residential investment by around 10%, compared to the baseline, that may actually reduce global GDP by 0.6% In the year, so then the cumulative impact of those two things is getting up towards 1%. And if we add a credit tightening channel in there as well, along with what we just discussed, you could plausibly get another 0.5% or so of GDP in a year. So adding all those things up, you can get an effect of about one and a half percent of GDP

Paul  22:34


is a change in numbers, in the context of global GDP of course

Adam  22:37

when you consider that the baseline is only for GDP globally rise by about one and a half percent anyway, which means if you, if you take off this one on a percent, you basically get zero or something, something near to zero. So with with this additional sort of impact, you can you can see global growth effectively wiped out and whilst this is the shocks that we're talking about here are relatively big, they're not absolutely colossal. So it's a plausible downside.

Paul  23:08

Yeah, so an absolutely crucial pivot point of the global economy to watch in 2023, then Adam Slater, lead economist at Oxford Economics, thank you very much for sharing your insights on macro bites. And thank you to you for listening to macro bites as ever, please like and subscribe on your podcast platform. But until next time, Goodbye and good luck out there.

Adam  23:40

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of Aberdeen. The companies discussed in this podcast have been selected for illustrative purposes only, or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.