![CBA, BankWest and AMP are lifting mortgage rates to cauterise surging demand from speculative investors.](/content/dam/images/1/m/d/i/c/l/image.related.afrArticleLead.620x350.gue97i.png/1487287933020.jpg)
It's clear that interest rates are too low in Australia and the United States, and thank heavens some smart bankers are unilaterally lifting mortgage rates to cool housing market exuberance inflated by the Reserve Bank of Australia's rate cuts.
On Thursday investors who had bought bonds with fixed rather than floating rates of interest were hammered by news that core US inflation in January was much stronger than markets predicted.
"Core CPI inflation was well above consensus expectations at 0.31 per cent in January, accelerating to 2.3 per cent on a year-over-year basis," wrote Goldman Sachs' Jan Hatzius.
Headline inflation was even brisker, jumping to 2.5 per cent over the 12 months to January.
This is materially above the Federal Reserve's 2 per cent inflation target and forced markets to upgrade to 40 per cent the probability that Janet Yellen will shock complacent "deflationistas" with an early hike in March.
"We have revised up our subjective odds of a rate increase at the March Fed meeting and now see it as a close call whether the committee raises rates over the next two meetings or waits until mid-year," Hatzius said. Goldman Sachs has a 90 per cent probability of at least one rate increase by mid-year.
Financial blog ZeroHedge noted that the "blistering" inflation report was the "highest in nearly five years" and pointed to the Atlanta Fed's sticky-price consumer price index (CPI) jumping "3.4 per cent (annualised) in January, following a 2.8 per cent increase in December".
US interest rate markets are the primary determinant of changes in the long-term price of money around the world and the inflation surprise pushed fixed-rate yields on AAA rated Australian government bonds up by 0.10 per cent.
(A tightening US labour market precipitating an inflation shock has been this column's central case for several years.)
Deutsche Bank's Torsten Slok criticised acolytes of the "low-rates-for-long" meme for clinging to weak US wages data in the January employment report, which some suggested could delay the Fed.
"The decline in average hourly earnings in January is a statistical fluke driven entirely by issues with wages in the financial sector," Slok explained.
"Markets should be paying more attention to Yellen's overall message than to one observation for wages, which is likely to reverse next month.
"The uptrend in wages seen since late 2014 continues, and this is what matters for discussions about when the Fed will raise rates."
Sanguine equity investors are nevertheless ignoring the higher cost of capital that is hurting anyone carrying duration risk with US sharemarkets rallying on the back of further data surprises, including better than expected retail sales in January (prior months were also revised up) and evidence US manufacturing activity is accelerating.
Locally bankers have prudently take matters into their own hands, with CBA, BankWest and AMP all (again) lifting mortgage rates to cauterise surging demand from speculative investors following the RBA's silly rate cuts.
While house price growth and auction clearance rates remain too high in Sydney particularly, out-of-cycle rate rises and regulatory constraints on credit creation should suck the wind out of market's sails.
It's also possible the RBA will pull its head out of the sand and address the core problem that has propelled Australia's housing bubble since 2013 — artificially cheap money — by jacking up rates before the year ends. (Don't hold your breath.)
One silver lining for bank shareholders is that the solo hikes may help forestall the inevitable decline in their returns on equity as the deleveraging process persists.
Last Friday the Australian Prudential Regulation Authority (APRA) jolted smug analysts, investors and bankers when its outstanding chairman, Wayne Byres, restated his view that banks must continue to "steadily build [their] capital" if they want to be "well placed to respond to future policy changes in an orderly manner". No, the capital raising debate is not over.
Byres declared that APRA's "main policy item" on its "agenda for 2017" was setting equity levels on the banks' balance sheets such that "the capital ratios of our deposit-takers are 'unquestionably strong".
On the same day the International Monetary Fund's annual review of Australia endorsed this goal, arguing that given our highly concentrated and commoditised banking system, APRA should "continue to actively encourage banks' efforts to robustly anchor their capital position in 'unquestionably strong' territory".
Byres has previously stressed that one measure of balance-sheet strength APRA will evaluate is the dollar value of the banks' equity divided by their assets, known as a "leverage ratio". When regulators allow banks to "risk-weight" their assets, which with home loans means they can assume that about 75 per cent of the asset is risk-free (or does not exist), their equity capital ratios appear to imply they are leveraged only 10.5 times.
But when they report leverage like all other companies do, the picture looks radically different.
During the week CBA disclosed that its leverage ratio was only 4.9 per cent, which means Australia's biggest bank is leveraging its equity more than 20 times. This is significantly greater than the leverage utilised by regional banks competing in the same market, which averages between 15 and 17 times.
CBA's higher balance-sheet risk, which also includes exposures to dicey overseas markets like India and Indonesia, is mitigated by the quality of its human capital, which is second to none under impressive chief executive Ian Narev.
I recall asking CBA's retail banking boss Matt Comyn some time ago why he didn't pursue some of the growth-seeking strategies adopted by rivals.
"They would be incompatible with our shareholders' and creditors' assumptions about the risks CBA assumes," was Comyn's blunt reply.
It was certainly welcome hearing a banker leveraged as much as a first-time buyer putting risk ahead of a singular focus on returns. CBA's chief financial officer put the point differently: "We don't want to compete in commoditised markets on price alone." That makes sense.
The author is a portfolio manager/director of Coolabah Capital Investments and Smarter Money Investments, which invest in fixed-income securities.
AFR Contributor