The BOC holds

Bank of Canada Governor Stephen Poloz surprised no one when he announced that the Bank of Canada’s interest rate would remain unchanged at 1.75%.

As Tembo outlined in our past post, analysts were divided over whether the Bank would emulate U.S. policies and cut rates or maintain them where they are. But the Governor’s carefully analyzed speech was also littered with a number of poignant warnings:

“Canada’s economy will be increasingly tested as trade conflicts and uncertainty persist. In considering the appropriate path for monetary policy, the bank will be monitoring the extent to which the global slowdown spreads beyond manufacturing and investment.”

In other words, we’re in for ever more difficult times. This was an important warning. The Bank followed up the warning by stating that global economic growth would slow this year to its lowest levels since the 08-09 crisis. The Bank acknowledged that its counterparts around the world have all eased interest rates but it is proud to be standing firm on its decision. The Bank is giving itself wiggle room in case the economy slows into a recession and the slowdown extends past the manufacturing and investment elements of the economy.

It’s important to note that Central Banks around the world are not only lowering rates but are intensifying their market intervention by buying assets and extending additional forms of credit to their member banks. In the United States, the repo frenzy Tembo touched upon continues. This signals that there is some leak in the international financial system, some lack of liquidity that needs to be plugged by cheap and rapidly accessible liquid capital. As we’ve noted before, a repo is when the Fed sells a financial product (bond) to big banks only to repurchase them shortly thereafter at a higher price, thus injecting the difference directly into the financial system. This is particularly effective in reducing short term interest rates in the money market.

Canada is in a stronger position than its international counterparts, as our BOC is not stimulating the economy to similar extents, but it is staying cautious and preparing for the worst.

Rate Decision Coming Up This Week

The BOC will be announcing its next move on rates on the week of October 28th. Whether they stay even or go down is a big question, but they most certainly won’t be going up anytime soon.

If rates do go down, expect the recovery and renewed dynamism in the GTA real estate market to be reinforced, and given added momentum. If they stay the same, the higher price and strong demand trends will stay healthy. Most experts predict that the BOC won’t cut rates. The number is low as is and the economic overall is perceived to be in very good shape. While BOC policy generally does not diverge much from the monetary policy of the Fed, many market watchers expect that the Fed’s recent push to lower rates and revive QE (quantitative easing) won’t be necessary in Canada. Unlike the U.S., Canadian politicians rarely criticize or even talk about the BOC at all. At the height of the very high interest rates of the mid 90s, the Bank was politely scolded, and politicians sent letters asking for rate relief. Lately in the U.S., as many of us know, the President is openly at war with Fed Chair Powell; his own appointee. The C.D. Howe Institute, an elite, neoliberal think-tank based on Bay St. is calling for the BOC to hold off on rate cuts now and to wait until early 2020 for cheaper money.

In Washington, the consensus appears to point toward a 3rd consecutive cut in rates by Chair Powell this week. U.S. economic data is weakening, with manufacturing and housing showing slowdowns and the bulk of now much more subdued GDP growth dominated by consumers maxing out their credit cards and increased government spending. The Fed has also quietly began to increase its book of financial assets, and has long since ended its previously strong commitment to incremental reductions of its massive balance sheet. This basically that the Fed is once again buying assets, intervening in the market, and artificially raising asset prices while providing cheap money stimulus to Banks. There is growing repo activity, where the Fed is selling government bonds to investment only to buy them back within days at higher prices – effectively providing the buyers with excess capital that is not loaned. Repo activity is oversubscribed lately and is running the many tens of billions of dollars. This suggests a need for capitalization among U.S. financial organizations. 

As Tembo predicted, the once high GDP growth achieved months ago by a Trump tax cut and low interest rate stimulus is now falling back into traditional territory. If Powell does cut rates again, it will signal that the Fed is both concerned at U.S. economic data and also sensitive to the pressure and open criticism it is facing from a President who refuses to temper his language and who revels in his own bombast. Under Trump, the U.S. federal deficit is climbing again and is now close to the $1 trillion dollar mark. If the U.S. goes into a protracted and deep recession, it will have little wiggle room, little capacity for sustainable government fiscal stimulus, and almost no room to lower rates. A recession anytime soon would likely spell serious political trouble for a President who is staking his political future on a booming stock market, stable economy, and gradual, albeit ephemeral foreign policy retrenchment. 

On the Fed Giving In

As predicted, Fed Chairman Jerome Powell acquiesced to the relentless pressure from the White House and yesterday announced a 25 basis point cut in rates. The constant stream of snipes from Trump’s twitter account finally wore Powell out. His news conference in announcing the cut sent mixed signals and received mixed reviews.

He cited a number of factors which influenced the decision to cut; international risks, low inflation, trade tensions, and weakening growth. He claimed the cut would support U.S. economic expansion and provide extra leverage to the country in trade negotiations. Powell was highlighting an economy at risk and slowing, but simultaneously preaching a favourable long term outlook. Market reaction to the cut was negative. Stocks went down, the dollar dropped, and precious metals rose. 

Some pundits lashed out, claiming the move was unnecessary, politically weak, and that the extra stimulus would overheat stocks. Trump immediately doubled down, furthering his criticism of Powell and suggesting that the Fed should have cut deeper with a clear outline of an even lower  rate trajectory longer term. Another mixed signal from Powell came in the form of his responses to questions about what the Fed would do next. Powell claimed that the cut does not mean interest rates won’t go up again in the near future while also providing vague answers on whether further cuts were on their way. Some pundits believe this cut, or ‘mid cycle adjustment of policy,’ signals an ‘inevitable’ move towards 0% rates, quantitative easing (money printing), and potentially negative rates (where the Fed pays banks to borrow). 

The impact will be felt in Canada soon. Rob Carrick, The Globe and Mail’s Finance Columnist heralded the cut as a positive move which ‘cancelled the apocalypse for overextended borrowers.’ He effectively outlines the case that rates in Canada will now be coming down as well. History has shown that the BOC’s interest rate trajectory takes it cues from the Fed. Governor Poloz has already said the orthodox BOC line, that a Fed cut won’t impact the BOC’s decisions and that Canada doesn’t need lower rates. At the same time though, the BOC has made it clear that it will analyze and keep a close eye on the Fed’s decision and ‘dissect’ the reasons provided for the cut. In the medium term, Powell’s decision will continue to reverberate, and the pressure on easing at home will continue to build. 

On The End of the Era of Central Bank Independence

It’s all over folks. We’re going down a new road. After intense pressure from President Trump and other members of his Administration to lower rates and boost stimulus, Federal Reserve Chairman Jerome Powell folded.

In his latest Committee Hearing with the House of Representatives in Washington, Powell outlined his view that the U.S. economy was showing signs of weakness and that the Fed would intervene more actively to stimulate it. Tembo watched the Hearing carefully and noted a stark shift in tone for Powell to a much more accommodating rhythm with a more humble persona than his usual confident, lawyer-investment banker stern self. Powell was in full listening mode. The transformation from Hawk to Dove is complete for Powell. This shift marks what is in many ways the end of Central Bank independence. Never again will the Fed be able to march on with its policies undeterred when a political figure with as volatile a record as Trump threatens the Chair with termination.

What was interesting about the hearing was the fact that Powell said that the Fed’s current huge balance sheet (now in the many trillions of dollars) was not an issue in again buying stocks and bonds ‘if it decided to do so.’ In other words, Powell was saying that even though we’ve become such an interventionist, buying bank to the tune of trillions of dollars, we’re happy to buy more if we need to. The Fed’s shift in tone was so strong that gold prices surged to multi-year highs. Markets enjoyed the capitulation of the Fed and showed solid gains. The Fed’s shift is a big win for Trump, as the political benefits from the likely economic gains from stimulus will help the President as he gears up for the 2020 election. Not since President Lyndon Johnson’s era in the late 1960s has a Fed Chair been under so much pressure from a President. But unlike the privately intimidating Johnson, Trump has been arms length, open, and very public about his disdain for the Fed’s unease of more stimulus and lower rates.

What this all means is simple. The Fed is now almost guaranteed to lower rates. It will also be much more open to reigniting the quantitative easing it pursued in the immediate aftermath of the last recession (buying assets in the open market). It is a huge political win for Trump, as his unadulterated, raw strategy of open criticism has now yielded results. When Trump started criticizing Powell he was widely mocked and attacked from across the spectrum. Nobody was used to this, and in previous political eras it would have been inconceivable for a mainstream, run of the mill politician at any level to attack the Federal Reserve or its Chair. For Canada, the Fed’s surrender will result in huge pressures on the BOC to cut rates as the game to lower the value of the dollar and lower the cost of money overall now begins in earnest.

Higher Inflation in Canada

Canada is an expensive place to live in. With a generally high quality of life comes high taxes, prices, and fees. Canadians pay some of the highest airfare, phone bills, and property taxes in the world. They also pay huge sums for modest real estate, as well all know all too well. Last month, inflation in Canada hit 2.4%, driven by a surge in food prices. Fresh vegetables and meat along with new car prices rose significantly. The only commodity that saw prices fall was gasoline, which recorded a 3.7% decline. Without the fall in energy prices, the inflation rate would have been 2.7%.

There are different definitions of inflation in the economics community. Some economists hold the view that inflation is solely an increase in prices. Others believe that inflation is almost always a direct result of an increase in the money supply driving up prices, more money in circulation means higher prices. In Canada, inflation monitoring, data collection, and targeting is sophisticated and well regarded internationally. The BOC has an inflation target rate of 2%, and is zealous is maintaining this rate. 

What last month’s figures mean is more difficulty for the central bank. On the one hand, economic growth is very modest and pressure to reduce rates to spur demand and lower housing costs is strong. On the other hand, the BOC is mindful of high debt, the need for a normalized rate environment, and now a growing trend of incrementally rising inflation. An interest rate rise now to blunt the modest increases in inflation we are seeing and would honour the BOC’s commitments to 2% inflation, but it would dampen the economy and irritate a number of sectors in need of debt. An election year makes the BOC’s task harder still.

Tembo’s read on all of this is that inflation rising will lower the possibility of a market favoured rate cut. If it continues to build up past 3% expect a rate hike unless the Fed gives in to growing pressures to reduce rates. 

Growing Pressure to Cut Rates

Senior economists from CIBC are making bold predictions on where interest rates will be going. They predict that the BOC will cut rates by 25 basis points next year, in lockstep with the Fed. This would see rates fall from 1.75% to 1.50%, if current rates hold. The rationale for the expectation of a cut follows weakening economic data, slowing growth, and a significant trade and account deficit. Banks have also reported financial data which shows Canadian contributions to their bottom lines seeing little to no growth, with the bulk of profit growth coming from U.S. assets.

In addition, pressure over mortgage stress tests has many believing that lower rates are necessary to give hope to the tens of thousands of prospective home buyers who have now been squeezed out of the market permanently. But the real overhang on this file has been the growing chorus of voices across the border which are demanding that the U.S. Federal Reserve cut rates, pump up the economy with more quantitative easing, and more efforts to stimulate a stagnant U.S. economy. The originator of much of this pressure has been Donald Trump himself. Trump’s language of criticism against the U.S. Fed and Fed Chair Jerome Powell has been consistently scathing for some time now.

Several days ago, the President tweeted that the U.S. stock market and economy would reach even higher levels if the Fed ‘did what China is doing’ by lowering rates and making the U.S. dollar cheaper in relation to competitors to boost exports. He also claimed that the Fed has ‘consistently been raising rates’ on his watch, seeing it as discriminatory. He also has stated the view that the stock market would reach record highs if the Fed lowered rates. At first, many called Trump’s language unprecedented and authoritarian, but now economists, market watchers, and business leaders are echoing his criticism of the Fed and are urging it to supercharge the U.S. economy so it can better compete with China. Lower interest rates are on their way. 

A Recovery That’s Gaining Steam

The latest stats are out and they’re very good for Toronto real estate. Sales last month rose by 19% from May 2018 figures. The number of transactions almost hit 9,900 and are approaching more robust historical averages. Home prices also went up by 3.5%, higher than inflation, and condo prices shot up 5%. The average home price in Toronto is now $838.5K, and the average condo price is $590K. Detached housing prices increased by only 1% to $1.042 million, but were marked by a much lower inventory and number of transactions, thus dampening dynamism.

Prices for condo townhouses are growing at the fastest pace, with a 6% increase recorded last month. Their combination of being relatively affordable and slightly more spacious than traditional condos has afforded them a great deal of attention with prospective homebuyers. Overall, new listings barely grew, and real estate experts claim that there is little capacity for this figure to expand, so further increases in prices and demand are anticipated – especially is sales continue to recover. If we have more positive months like May, expect price growth to rapidly rise once agai
n. To put this very positive month in perspective, the market has now returned to the levels it was at shortly before the introduction of stress tests. This shows how strong the underlying fundamentals of GTA real estate are. 

While we have a long way to go before we see prices and demand for detached houses reach the dizzying levels of March and April 2017, semi-detached and condo townhouse figures are almost at their Spring 17′ peaks. Condo apartment prices almost never fall in Toronto, so positive trends for a quarter or two should get numbers to meet Spring 17′ peaks as well. The $1.2 million average detached home price levels which marked Spring 17′ are a long ways away but not impossible to revive. GTA monthly unit sales reached a high of almost 13,000 in mid 2016, and at the beginning of 2019 were barely at 4,000. If trends continue we should see a few more months of rising sales. Keep in mind that there are growing rumours of an incoming BOC rate cut, in addition, Canada’s big banks will likely work to revive growth in domestic credit and mortgage operations, so incentives and lower rates may be well on their way!

On an Interest Rate Cut

For almost a year, Tembo has repeated a consistent and simple message. Our view was that the Canadian economy relies massively on low interest rates. Higher rates would cripple our nation’s real estate sector, its financial industry, and would raise borrowing costs on strained small and medium sized businesses. Higher rates would also force government across the country at all levels to cut spending and rein in their large deficits. But we also acknowledged that too much easy money for too long a time would weaken the economy, overload it with debt, and incentivize speculative economic activity.

We foresaw that rates would rise rapidly given recent trends as central banks wanted a healthy interest rate cushion in case of a recession. They did. 

And then, just as Tembo predicted, the BOC backed off. Weakening post-Christmas spending activity and a stagnant real estate rebound in early Spring unleashed a torrent of sub-par economic data. That, coupled with a topsy-turvy global macroeconomic and political situation, spooked not just the BOC, but Central Banks around the world. In the U.S., Trump and his Chief Economic Advisor Larry Kudlow berated the Fed for its higher interest rates and its wind down of monetary stimulus. Their sharp criticism forced Fed Chair Jerome Powell to participate in a rare interview where he ex
pressed the view that he could not be fired.

Now, media reports and rumours are spreading outlining the growing possibility of the Fed cutting interest rates by half a percent and intensifying asset purchasing and macroeconomic stimulus. If such a move would occur, the BOC would effectively be boxed in to cut rates here at home as well. A rate cut in Washington would likely raise the value of the Canadian dollar to the benefit of Canadian consumers. But, the growing rumours, if materialized, would mark a potent change of course and policy. How quickly times change. 

On the Return of Low(er) Interest Rates

It’s back to the future time in Canada. The steadily higher interest rate trajectory that was to be the new normal now appears to be officially dead and buried. With the U.S. Fed signalling an end to higher interest rates and trumpeting its newfound zeal and preparedness to accommodate markets, the BOC had no choice but to emulate.

The BOC’s head body, the Governing Council, made the point that an “accommodative policy interest rate continues to be warranted.” The BOC made its point about the need to keep rates stimulative at the same time as it cut its GDP growth forecast for the national economy to 1.2% from 1.7%. Canadian bond yields and the dollar both fell in response to the news. The clarity of the BOC’s words are striking and diametrically opposite from its firm and disciplined messaging when it repeatedly made the point that it needed to raise rates not long ago. It also suggests that there is an anxiety with monetary policy heads and a perception that the economy increasingly requires propping up. 

 

In Tembo’s opinion, the BOC’s announcement is extremely important for all Canadians and particularly for mortgage holders and prospective home buyers. This announcement from the BOC is strong positioning for stimulus, lower rates, and potential buying of stocks or securities to boost prices, reinforce demand, and service the financial sector. 

 

The implication of this announcement outlines the incoming reality of lower rates, cheaper mortgages, and the BOC reinflating the housing bubble back to more dynamic levels. Canadians should prepare for tighter finances to be safe but should also expect money to become cheaper in the months to come. 

On Real Estate Predictions for Spring 2019

It’s hard to predict real estate trends and long term changes. Experts, economists, and real estate watchers will all have their views. Southern Ontario and GTA residents are generally positive about the long term fundamentals.

 

They believe that immigration, a stable economy, and a sound financial system will all facilitate long term growth and general real estate stability. This positivity comes from the fact that since the early 1990s, the real estate market has been on a positive upswing. Only two brief periods saw prices and demand ease, in the early 2000s with the popping of the dot-com bubble, and in 08-09, with the Great Recession.

 

Overall, given the data we now have and the trends we’re aware of, there is little that suggests there will be drastic changes to the real estate market. Expectations suggest that the price growth we saw in the last few years are unlikely to return. Interest rates will remain stable. While the BOC will want to raise rates when necessary, there is the dual pressure of not overwhelming consumers with higher borrowing costs and managing economic expectations.

 

Demand will continue to be strong. Experts are predicting stable or increased demand for luxurious apartment and detached home units as international money shifts out of Australia, the UK, and New Zealand in favour of Canada and the U.S. Condo prices and demand are likely going to trend higher, as detached home prices are still too high for first time buyers. As for prices and sales, both are expected to trend upwards in the Spring. A 30 year fixed rate mortgage is trending at 4.375%.