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 again. 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 expressed 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. 

Bully Bids and Bans

Ontario’s powerful realtors and their respective lobbying vehicle, the Ontario Real Estate Association (OREA) have asked Doug Ford’s provincial government to outlaw the practice of ‘bully offers.’

A bully bid is an offer submitted by a prospective buyer ahead of a seller’s established offer time. These bids are largely designed to aggressively pre-empt purchasing activity from other potential buyers and to place pressure on the seller to accept. This aggressive bid is submitted before the designated offer day. Sellers accept the bully bid if they believe that it will exceed what they will get conventionally. 

The practice can occasionally result in one buyer out-muscling potential counterparts and entices a seller to close a deal quickly without reviewing and considering other potential bids. The move is seen as unfair and limiting to realtors, who have little room to bid up prices if only one bid is submitted and ultimately accepted. Realtors also feel banning bully bids would enhance fairness in the market and allow all prospective buyers, or at the very least a greater number of them than present, will be allowed to participate in bids. OREA submitted 28 recommendations on reforms to their profession to the government which is currently reviewing the Real Estate and Business Brokers Act; the landmark legislation governing real estate professionals.

OREA is headed by Tim Hudak, the former Leader of the now governing PC Party of Ontario. The organization is heavily staffed with politically minded employees and is close with the present administration and enjoyed reasonable ties with the former Liberal Government. Several PC lawmakers and government staffers are former realtors and the government is keen to develop and maintain strong ties with realtors, developers, and the construction industry. These groups have heavily bankrolled the PC Party in the past. 

 

Mixed Real Estate Conditions and a Potential BOC Rate Cut

 

The Greater Vancouver Real Estate Board released rough real estate stats earlier this week. Reports showed that year-over-year Feb. residential home sales fell over 30%. This represents the worst Feb. sales total since 1985, over 40% below the last decade’s average.

Detached homes lasted roughly 55 days on the market before sale, while townhouses averaged 39 days and apartments and condos at 40. Prices also fell by over 6% year-over-year, while at the same time, inventories are piling up. Total listings rose by over 48% year-over-year to almost 11,600.

In Toronto, prices rose by 1.6% while listings fell 6.2%, sales fell by 2.4%. Canada’s banks are also feeling the heat of an inconsistent real estate market. Credit losses rose by double digits at the big 5. The same credit losses were seen in the Australian banking and real estate markets as well and in other countries dependent on real estate.

Economic stats have dipped into such negative territory so quickly that news is spreading of the possibility that the BOC may cut rates soon. Tembo has consistently made the point that the BOC will stick to an aggressive and consistent rate hike trajectory until economic conditions change. While most experts believe that rates will stay put, the potential for a cut will grow if economic conditions continue to worsen. As we previously reported, the economic recently contracted by a very narrow margin.

On an additional note, the City of Toronto will convene on Thursday, March 7th to pass its 2019 budget. The budget outlines a massive drop in land transfer tax revenues because of stalling real estate conditions. The City has become addicted to the previously perpetually rising land transfer tax which financed large increases in city spending. That era has come to a close.

SNC Lavalin Scandal Could Change Canada’s Government

The Federal government is reeling from the pressure of a scandal that has shaken elite circles across the country. Extensive media coverage in the last several days has widely revealed the scandal to the public – we are of course talking about the Jody Wilson Raybould and SNC Lavalin. 

In essence, former Attorney General of Canada, Jody Wilson Raybould refused to provide a deferred prosecution agreement for SNC Lavalin – a Quebec based engineering giant. SNC Lavalin had previously bribed the government of Muammar Gaddafi in Libya for construction contracts. Despite tremendous pressure from the Prime Minister himself, high ranking public servants, and other leading political figures, Jody Wilson Raybould refused to yield. 
SNC Lavalin employs thousands in Quebec and Montreal, the home province and home city of Justin Trudeau. It is a well connected and storied company, with deep political connections. The Liberal Party of Canada has long had deep ties with large Montreal firms and the city’s old money aristocracy. As for Mrs. Wilson-Raybould, she revealed the extent of her principled core values and followed in the footsteps of her father – who fought political battles with Justin Trudeau’s father, Pierre Elliott Trudeau. Mrs. Wilson-Raybould and her father are well known and respected Indigenous Canadians. 
The now fully unveiled scandal has led to a media frenzy, a sharp drop in opinion polls and support for the government, and Ottawa’s dirtiest laundry now out in plain sight for the public. Media commentators were all ubiquitous and sharp in their criticism of the Prime Minister – many of whom suggested that he should resign or that the government’s reputation is now seriously compromised. The scandal also led to the shock resignation of Trudeau’s Principal Secretary Gerald Butts, the second most powerful man in Ottawa and one of Trudeau’s closest personal friends.
While this year’s federal election is still 7 months away, an eternity in politics, the SNC Lavalin scandal continues to unfold. The instability could fuel more political drama and both opposition parties will look to take advantage. 

As Economy Slows, Bank Of Canada Holds Off On Interest Rate Increase

Instead of raising rates again the BOC (Bank of Canada) decided to hold off. With oil prices still low and the national economy losing the consumption boost of the holidays, the bank decided to give the economy a breather. Rates remain at 1.75%, with inflation having fallen to 1.7%, under the BOC’s benchmark of 2%. 

Bank of Canada Governor Stephen Poloz

The BOC’s decision mirrors that of the Fed in the U.S., where Chairman Jerome Powell recently outlined that the U.S. Central Bank was ‘flexible’ and would also ease off on money tightening given recent stock market fluctuations. The BOC pause flies in the face of the past consistency of its rate rises. It’s also likely that there is growing pressure on the BOC from a wide variety of market sources, especially given recent negative real estate statistics.

Keep in mind that this is an election year in Canada.

Prime Minister Justin Trudeau

Politicians despise higher rates for obvious reasons. The BOC would be wise to include political considerations into its decision making, and stretching out the rate rise schedule would be helpful to Prime Minister Trudeau.
Overall, the pause will be beneficial to the real estate sector, especially given recent difficulties and poor stats. Political efforts to cool the market could easily shift to a desire to cushion the sector and strengthen it. Lower oil prices and weaker consumption will also reduce inflation, further pressuring the BOC to hold off on rate rises. To facilitate economic stimulus in the event of a hypothetical future recession, the BOC would ideally need to quickly cut rates by roughly 4%. This is the likely target long term. 

We Are Barely Into 2019 And The Stock Market Is Already Making Some Wild Moves

2018 ended with significant stock market turbulence around the world, especially in New York and Asia. Tembo made note of this in its final 2018 blogs and newsletter (you can sign up here). As we mentioned, significant drops in the DOW were reversed by announcements that major pension funds were pouring over $64 billion into stock buys, moving away from their positions on low yield bonds. 

Canadian Stockmarket Turbulence

Apple CEO Tim Cook’s Investor Letters Causes Stock Market Jitters

Even as this news drove up confidence, the market tumbled again when Apple Co. CEO Tim Cook released a brisk letter to shareholders that stunned Wall Street and which the media called a ‘bombshell.’ The letter outlined many positive overall trends for the firm but admitted its revenues and profits were to be negatively affected by ongoing economic disruption. Sales of new Iphone devices, especially in Greater China, did not meet expectations, and gross revenue would be over 5% lower than forecast.
Tim Cook Investor Letter
Apple’s reputation as a practically indestructible giant with an unrivalled brand and relentlessly improving financial performance was hurt badly by the letter. The company’s share price fell by 10%, equivalent to over $70 billion. As so many market participants, analysts, and traders have never experienced a bear market from a low interest rate boom that has lasted a decade, the tough news was not taken well. Markets negatively reacted to the news, with the letter solidifying growing perceptions that the global economy is undergoing significant structural changes.

Fed Tries To Calm Markets

This week some good data restored confidence. Another big boost to the markets came from Federal Reserve Chairman Jerome Powell, who commented that his central bank’s policy was ‘flexible’, essentially calming the market by saying the Fed would act if further market drops occurred. It’s Tembo’s belief that the Fed will cut rates quickly and print money to buy stocks if the stock or asset (real estate) market’s fell harshly – for better, or for worse. 

On Canada’s Wealth

There has been a fair amount of media coverage over the last few days from an interesting, recently released stat from StatsCan on Canadian net wealth. It seems we’re a lucky country – our net wealth has topped $11 trillion, and our economy produces goods and services worth near $2 trillion.

Toronto Banks
The $11 trillion net wealth number was not a surprise for experts, but what has piqued the interest of observers has been the real estate component of that huge net wealth figure. The value of real estate represents over 75% of our net wealth, or just under $8.8 trillion. 
Over the last decade, real estate rose from comprising roughly 62% of Canada’s net wealth to the aforementioned figure. Canadians are much more dependent on real estate for their wealth than Americans – in the US, real estate has generally held steady at just over 70% of net wealth. This statistic corresponds to the general macro-economic trend that has continued in Canada over the last decade, where low interest rates and government policies have leaned on real estate and construction to drive growth. Low interest rates, strong demand, and the inability of the private sector to consistently build enough housing has all acted as fuel to real estate prices, and thus equity and net wealth.

Canadians Are More Dependant On Housing For Their Wealth Than Ever Before

Most Canadians hold the view that inevitably over the long term, their home equity will continue to rise. Many baby boomers and older Canadians are depending on this (rising) equity to supplement their pensions for consumption in retirement and to pass resources on to their children and grandchildren. This belief in relentless home price increases should have been tempered given the turbulence the national real estate market experienced over the last year and a half. The stats show that we are more dependent on housing for our wealth than ever before in our history, and even more so than our real estate crazy neighbours to the south. What we must all remember is that so much of this wealth is based on debt, and that debt needs to be serviced through discipline.