A Coronavirus Related Rate Cut?

News keeps building on the spread of the coronavirus around the world. South Korea has reported a thousand cases of the disease and over 50 deaths, with these numbers rapidly rising. The South Korean Government has responded by emulating the Chinese in quarantining whole cities.

Keep in mind that a little over a week ago South Korea’s coronavirus numbers were negligible. Cases of the virus have been reported across South Korea’s demilitarized border in the notoriously isolated North Korea – despite that country shutting down its borders, and even reportedly executing the infected. But the coronavirus is spreading well beyond East Asia. Iran is reporting a rapidly growing number of cases and deaths despite a negligible presence of the virus not long ago. Iran’s Minister of Health was recently seen delivering a press conference on the virus sweating profusely, coughing, and appearing weak – a sign of the severity of the outbreak, according to international media.

In Italy, the virus is rapidly spreading and prompting reported shortages of goods in stores and growing unease. These are the most high profile country cases of the global outbreak, with fear growing around the world, especially in Hong Kong, Taiwan, Japan, and Singapore. Over the last several days, media attention on the outbreak has become increasingly fearful and the apprehension has already hit international stock markets. U.S. markets are falling precipitously and experts are warning that the virus’ impact on international supply will be severe and widely felt. As we all know, China is the workshop of the world and the planet’s biggest exporter of goods ($2.5 trillion annually). Chinese companies are involved in the production processes of everything from steel to pharmaceuticals to computers to drones,. If Chinese factory output remains negatively affected by worker anxieties over the virus, global supply chains will be damaged.

In response to this intensifying and ongoing issue, financial experts and economists have already begun to call for the Federal Reserve to cut rates. The Wall Street Journal is following and reporting on the outbreak closely and featured an article where the rate cut argument was made. The front page of the paper ran a headline stating that the virus was beginning to take its toll on the global economy. The supply chain pressures experts are warning about have yet to be truly felt. The Federal Reserve is obviously monitoring the situation carefully and has not yet provided detailed comment on the virus outbreak. This goes for the BOC (Bank of Canada) as well. It is likely that if the severity of the virus continues to accelerate and if global markets continue to be negatively affected there could be a comprehensive international response – central banks acting in unison to stimulate the world economy. 

Employment in Toronto

Toronto’s economy supports 1,569 million jobs. 1,178 million are full time and 390K are part time. The average wage of a full time worker in Toronto is just over $60,000. Job growth in Toronto has been healthy and consistent for over two decades.

Throughout the mid to late 1980s, Toronto saw impressive economic growth, real estate appreciation, and strong performances by financial firms and pension funds. Employment reached a peak of 1.4 million in 1989 and then fell to under 1.2 million by 1997 as the real estate bubble burst and the early 90s recession kicked in and ran its course. A recovery followed, buoyed by the dot-com bubble. Since 2010, however, the rate of employment growth has been rapid and consistent year-on-year.

The institutional sector is seeing significant job growth. Universities, Colleges, private education employers, and hospitals have collectively added 17,000 jobs in the City in the last two years. Growth is at three times the rate of inflation in the institutional sector. Office jobs went up by 23,000 in the last two years, while the rate of growth over the last five years was 16.7% in that space. This impressive job growth underpins the ambitious construction of commercial office projects throughout the City that Tembo has outlined in numerous blog posts. It is driving a very low commercial vacancy rate which has been falling for many years and which sends a clear signal to developers on opportunities in the market.

Manufacturing, retail, community and entertainment, and the service sector all saw gains but these were mode modest than the office and institutional sectors. There are over 77,000 businesses in Toronto, up from a decade ago but lower than its absolute peak of just under 85,000 in 1990 at the height of the late 80s boom. 48% of Toronto jobs are office jobs, with the institutional sector coming in at number 2. Health care and financial service jobs are seeing the biggest gains in the last five years. Obviously, most of the jobs are in the downtown core.

A snapshot of Toronto’s economy & construction sector as we wrap up 2019

In this blog post, Tembo will give its readers an overview of the state of Toronto’s economy and its major financial indicators. In this way, Tembo hopes to reveal the overall good shape, flexibility, and versatility of Toronto’s economic state. All in all, Toronto’s economic indicators are very positive.

The Macro-Economy

  • Unemployment is at 6.9%, slightly higher than the national figure but still a decent number, remember that population is rising by 70,000, placing pressure on job creation.
  • Mean hourly wages in Toronto meet provincial and national averages, at $29.
  • GDP is growing by roughly 2%, at the rate of inflation, it’s projected to stay at this amount for the next several years. The economy had a strong growth spurt from 2014-2017
  • Toronto’s economy boomed from 1998-2001, averaging rates of well over 5% in those years
  • There are 1,572.4 million jobs are in Toronto, contributing to an office vacancy rate of 4.1%, there have been only 10 business bankruptcies in our City this year
  • The industrial vacancy rate is 1.5%, down from 5.5% in late 2013
  • Consumer prices rose by 1.7% this year
  • Retail sales in Toronto will exceed $32 billion for 2019, most of which was cars and car parts

Buildings under construction

  • There are 246 mid and high-rise buildings under construction in Toronto as of October 2019, up from 202 in October of 2018
  • The pace of building continues to rise, Toronto is competing with New York City for the title of most mid to high rise construction in North America
  • 2022 will be a giant year for construction in our City as there are a huge number of supertall buildings that will be completed in that year
  • These will include the 83 floor The One building at Yonge-Bloor, YSL Residences at 85 floors just down the street, and Sugar Wharf Tower D on Queens Quay which will reach 70 floors
  • This article from the Financial Post has lots of information and an interactive video of some of the supertall structures that are being built right now: https://business.financialpost.com/real-estate/property-post/vertical-city-80-new-skyscrapers-planned-in-toronto-as-demand-climbs

Housing

  • Disappointingly, housing starts in Q3 2019 were 9% lower than in Q3 2018 but are up 11.5% from Q2 2019
  • There were roughly 5,000 housing starts in Q3 2019, most of which were apartments and condos
  • The average house price in our City is $925K

Most analysts and experts consider Toronto’s economy to continue

to remain healthy and reasonably stable in the coming years. Analysts believe the biggest threats are high debt levels, a rapid rise in interest rates, or a severe recession from abroad.

Emulating the Singapore model to boldly solve Toronto’s Housing crisis

Toronto is in the midst of full-blown housing crisis whose severity will soon stretch and tear at our City’s social fabric, inflame socio-political tensions, further erode our resident’s quality of life, and cripple long term economic potential.

Over two decades of insufficient private home building, historically unprecedented low interest rates, and an ongoing torrent of foreign capital investment have created a market Swiss investment banking giant UBS recently crowned “the world’s second biggest City housing bubble.” We have reached the stage where average housing unit costs have hit $880,840 pushing the price-to-income ratio to 8.2; meaning that average housing costs over eight-times gross household income, almost three times higher than ideal levels.

Buying a home is not the only challenge, with a rental market experiencing a surreal vacancy rate of 1.5% and one-bedroom apartment rent rapidly approaching $2,000. Our housing market is poorly structured and caters to investors, many of whom are foreign. Much of our private building capacity is dedicated to building miniscule, overpriced, shoddy but exceedingly profitable condominiums. Recently released data from Statistics Canada asserts that up to 37.9% of these units are vacant.

Superficial pledges from the political class and incremental, modest increases in investment (HousingTO, TCHC subsidy reform, foreign buyers’ tax) that we have seen in recent years do not address the fundamental underlying dysfunction in our market, and are window dressing measures that will do little to nothing to solve Toronto’s housing crisis. Like Singapore in 1960, Toronto is experiencing a severe shortage in housing, sustained population growth, and untapped economic potential. Singapore’s response to its past housing crisis has been internationally respected.

The country created a Housing and Development Board (HDB) that efficiently and rapidly built quality rental apartments to sell at below market rates to needy citizens. Within 5 years, the HDB built 51,000 apartment units and ended the supply shortfall. Today Singapore has a 90% home ownership rate and over 1 million publicly built, privately owned apartment units. Public housing in Singapore is of very high quality and occupied by all classes, rich and poor. Toronto’s public stock is crumbling despite record investment that will still fall short of needs. We have a waitlist of many tens of thousands who realistically will have to wait decades for affordable housing or will never get it at all. Transferring ownership of our public housing stock to current tenants will permanently transform the lives, shift repair liabilities off the city’s books, and free up resources to decisively and honestly resolve our housing supply crisis.

Canada’s population is exploding

Out country has had an interesting history of immigration stretching back hundreds of years. Throughout the late 19th century, immigration was modest compared to modern levels.

Annual immigration averaged roughly 25-50,000, topping 130,000 in the early 1880s but then falling to 80,000 in the 1890s and dropping precipitously in the late 1890s and early 1900s. A huge surge then occurred from 1902 to right before the start of the first World War. With the prairie provinces Alberta and Saskatchewan admitted to Confederation, elites recognized the urgent need and positive opportunity of settling the Western prairies and activating the agricultural potential of the region. Sizable grants of effectively free prairie land were advertised to European migrants, particularly those from Ukraine, Germany, and Poland, on the condition of long term settlement and productivity inducement. 400,000 people entered the country in 1912, an all time single year record.

In the 1920s and through the Second World War immigration began to fall until it recovered in the post-war boom. Over the last 20 years immigration levels have been high and steadily increasing, with both main political parties supportive of the trend. Average increases varied from 200-250,000, but the current Liberal Government has shown a zeal to increase this number further to 350,000+. Statscan has released data that shows recent increases in population have hit all time historic highs that have topped the traditional pre-WW1 figure of 400,000. From August 2018 to July 2019 the population of our country increased by 531,000. 60% of those immigrants settled in Ontario and British Columbia. These kinds of increases show that our immigration system is moving aggressively to address the most serious demographic issue we have; an aging population. Hopefully many of the new entrants are family sponsorship individuals who have likely been waiting for years to join with family members who are already here.

One can imagine the impact of this population increase on a housing market that is already squeezed from demand pressures. Even if immigration levels fall from this record high, they will still be significant in the years to come. The consensus on high immigration levels is shared by most of the political class, big business, and a significant chunk of the population. This won’t change anytime soon. Record high immigration are the new norm and this will continue to fuel rapid growth and housing prices. 

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. 

The Benefits of Turmoil Abroad

With political and economic instability growing around the world, havens of stability and calm will be increasingly sought out by the aspirational middle classes, the wealthy, international businesses, and savvy investors. Canada is one of those safe havens.

While we are in no way a country bereft of serious issues, our political system is stable and not as divided as structures in the U.S., Europe, and parts of the Middle East. Our economy is in decent shape, and we have lots of untapped potential long term. We are also a tolerant and open society where openness to polarizing rhetoric is extremely limited and always has been. The world is well aware of our positives, and Canada has a solid international brand.

In Vancouver, the foreign buyers tax, shifting psychology, and an activist NDP government in Victoria have all blunted real estate. Developers continue to hold back on new construction and prices continue to fall. Chinese money no longer looks to Vancouver real estate as a safe haven. The city has worn out the welcome of foreigners and the shock of government intervention has not lifted. While Toronto’s foreign buyer tax remains unpopular with the real estate lobby, the city’s economic preponderance and heft have allowed it to absorb the consequences of the foreign buyer tax well. Significant sums of money were redirected to Toronto in light of Vancouver’s foreign buyer tax briefly, and much of that momentum is now moving further east; to Ottawa and Montreal. 

In Hong Kong, the political situation is becoming dire. The Chinese government has assembled significant military infrastructure adjacent to the city and has warned that its patience in tolerating the city’s mass protests is almost up. A direct Chinese military intervention is restoring stability to the global financial hub would have a drastic and immediate impact on the Hong Kong economy and its status as a stable centre of finance and business. Media reports in Canada and abroad are already suggesting that Hong Kong residents of means will begin moving out of the city to Taiwan, Singapore, and Korea. They will of course, be transferring their money and assets out of the city if they fear that a Chinese crackdown on dissent would affect their livelihoods. Either way, for now, Canada is well positioned to continue to be perceived as a financial and political safe place in a turbulent world. 

A Very Good July for Real Estate

Just look at these numbers, a 4.4% increase in prices from June figures, sales up over 24% from July 2018, and overall sale prices up 3.2% from July of 2018.

The average Toronto home sold for just over $806K. The number of properties that were sold went up to 8,595 from 6,916 from June. This is a huge increase, and all of those numbers were well above official inflation rates. As always, supply of the most desired real estate was tight, driving up prices, limiting options, and redirecting supply to less dense markets and different real estate products. Listings were down 9% from July 2018 numbers, outlining the extent of declining stock. In the rules of supply and demand, when supply contracts prices rise, and the cooling of the market that we’ve been used to recently definitely cooled the market.

tress tests are still around, but their shock has subsided. Families that were locked out by the tests have had more than a year to re-calibrate, to save more money, and discover new financing options. Some may have decided to buy a condo instead of a town-home, or decided to start their real estate equity in a small town as opposed to a cozy suburb. Prospective buyers who saw a cooling market pulled their listings and decided to wait the market out. The contraction in listings that followed are now seeing their impacts fully felt and that pressure is starting to turn 2-3% increases into 4% price increases. All in all, the market is re-orienting back to a more dynamic state, at least for now. 

 

But Tembo feels that certain international pressures could align to add even more oxygen to GTA real estate. First off, as we’ve reported, the Fed cut rates. Within a few days, President Trump lambasted the Fed for not cutting rates FURTHER. Market changes and instability that Tembo will outline in its newsletter have created immediate international reactions to the Fed rate cut and other socio-economic and political changes. Tembo predicts that the BOC will cut rates soon, especially if the pressure to keep monetary easing going builds up in Washington and around the world. Home prices across Canada have remained roughly static for the last two years and rate cuts at home could shift that momentum to price growth. 

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.