20130218 SCMP article - Quantitative Squeezing

below is the original text before being modified for publication in the SCMP. But I liked my original passage more, so here it is:

Bull view: quantitative squeezing

There has been a lot of talk of a housing market bubble in Hong Kong and that interest rate rises may precipitate a price collapse soon. I argue otherwise. Here are three reasons why.

We live in a time of high inflation and low interest rates. The world is awash with cash thanks to the money-printing programmes of the world’s biggest central banks (Japan, the US, the euro zone), and even some emerging %market countries).

First, superior returns. Compared to “safe” or investment grade instruments from deposits to government bonds, which are generating negative real returns – that is, real yields of -2.5 to -3.5% – real property yields although also negative, are a more palatable 0% to -1.5%. This also explains why Hongkongers have been buying high-yield bonds and, more recently, equities. These can generate returns above inflation. However, they have higher corporate, credit, and supply risks, whereas property does not suffer any of these drawbacks.

Second, inflation hedging. Property is also a great hedge on inflation, which is the big bogeyman lurking on the periphery, thanks to unprecedented and radical use of quantitative easing by global central banks. While rental income rises alongside inflation (as any leaseholder knows), a 10-year bond issued today with a one per cent coupon will yield that same one per cent for the next 10 years.

Third, governments’ need to hold rates down. With global central banks in a “race to debase”, money supply growth should continue to run high in the double digits. If the free market were to determine interest rates, fast depreciating currencies would lead to sky-high interest rates to compensate for the risk of lost purchasing power. However, central banks will hold down interest rates down near zero in order to boost growth.

So what about the prospect of rising interest rates, given Hong Kong housing prices are highly sensitive to interest-rate rises? My conclusion is: barring hyper-inflation, central banks will not hike rates for another 3-4 years. Excepting a handful of oil producer countries, all governments worldwide are running on large and structural budget deficits, with the developed countries seeing their debt burden approaching or exceeding 100% of GDP. If the USA GDP growth is already at an anemic 2%, a two percentage point rate hike will wipe out all growth, and put politicians out of their jobs. Now, if you are the head of state of any of the advanced economies, will you let interest rates go up?

Hong Kong property will fall, but only after another 20 per cent-plus rise has kicked in over the next few years.