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. 

Mortgages Stress Tests Are Slowing Canadian Real Estate Market

The head of one of the country’s largest and most influential real estate bodies has made a strong case to one of the nation’s foremost regulatory bodies to ‘revisit’ its support of stress tests. The head of the Toronto Real Estate Board has complained that stress tests are too cautious and are having an extreme dampening effect on the market.

As a reminder to our readers, stress tests were implemented by the federal government in 2017 to reduce risk of poor mortgage lending and to shore up the housing market.

Stress tests scrutinize mortgage buys from prospective buyers with deposits at less than 20% of the purchase price and with no mortgage insurance. Stress tests provide incentives to purchase mortgage insurance, which can be costly, and add another layer of analysis to the already comprehensive mortgage approval process. Canada’s already notoriously conservative banks were made even more scrupulous with the introduction of the stress test.

Stress Test Have Dampened Demand

Stress tests were designed to demonstrate whether a low deposit mortgage could withstand a 2% added interest rate cost from the BOC. The effects of these stress tests have been to dampen demand. Research has shown that stress tests effectively blocked up to 100,000 first time home buyers from being approved for a mortgage. They were supported by risk-averse bureaucrats and economists who fear a housing bubble and who are worried about the quality of mortgage issuance in the country.
In response to these complaints, the OSFI, or Office of the Superintendent of Financial Institutions, Canada’s core banking regulator, stated that it will be sticking to the stress tests. In addition, it made the point that the stress test adds a margin of safety that is ‘prudent.’ With weakening real estate data spreading around the country, pressure from real estate bodies and experts on regulators and the Bank of Canada will continue. 

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. 

On Oil Prices And A Cautious Bank Of Canada

2018 will end without an increase in interest rates. The Bank of Canada (BOC) announced on Wed. Dec. 5th that its benchmark rate of 1.75% would hold steady. The enthusiasm and confidence the BOC previously expressed about the overall state of the economy was gone in its most recent announcement.

Alberta crude oil

The continuing collapse in oil prices, record high mortgage and consumer debt, and slowing economic growth were the key factors the BOC cited as dead weights to the economy. In response to the lack of rate tightening, the loonie fell to stabilize to 75 cents. The BOC is especially pessimistic of the long term prospects of Canada’s energy sector.
The news will come as a sign of relief to the real estate sector and will result in a pause in the general trajectory of higher mortgage and interest rates seen over the last few months. Mixed real estate data underpins the need for more caution from the Bank. The fall in the exchange rate will also benefit manufacturers, especially those in southern Ontario and parts of Quebec. While static rates will help Western Canadian consumers and businesses, their pain is significant and cries for assistance and greater government intervention are being made by Alberta and Saskatchewan Premiers Rachel Notley and Scott Moe. 
Canadian crude oil is being priced at rates as low as $14 a barrel – even as U.S. crude has rarely ever sells for less than $50 a barrel. With existing Canadian pipelines at full capacity and oil shipped by train overloading rail networks, there is essentially no room to maneuver for exporters who can’t get their product to market efficiently. The Federal government’s plan to expand pipeline networks to B.C.’s coast have failed due to legal challenges and resistance from apprehensive and environmentally conscious First Nations groups. Pipelines planned to the east coast (Energy East) face considerable regulatory, financial, political, and social hurdles. The failure to properly export Canadian oil has been a recurring strategic economic challenge for many decades. 
Oil’s fundamental importance to the Canadian economy was highlighted in the value of the exchange rate from 2010 to late 2014, when Canadian oil sold for $80-100 a barrel. In those years, the Canadian dollar approached or met U.S. dollar parity – fuelling a boom in cross border shopping, and strong domestic and corporate leveraging. How times have changed.

Bank of Canada’s Huge Announcement On Mortgage Bonds

On Friday, November 23rd at 10am, the Bank of Canada issued a ‘market notice’ announcement with big implications. For the first time, the Bank stated that it would begin making innovative additions to its balance sheet: the purchase of mortgage bonds, or mortgage backed securities.

The news was not announced in a press conference or a press release, but a sleepy ‘market notice’ at the bottom of the Bank’s media/press page on its website.

So, What Are Mortgage Bonds?

A mortgage bond, or mortgage backed security (MBS), is a financial product that is made up of many mortgages, let’s say 100 for example. These mortgages are usually issued at the same time, at the same mortgage rate, and generate interest (income for the purchaser). Buyers could be Canadian banks, foreign banks, and domestic and international investors. 
Mortgage backed securities were at the heart of the 2007-8 financial crash. The bonds were given the highest credit ratings, (what’s safer than a mortgage/house as an investment?) and were scooped up by clients all over the world. What buyers didn’t know was that many of these mortgages were poorly underwritten, and very risky. When foreclosures started kicking in the bonds went bust, and clients lost tons of money.

Why Is The Bank Of Canada Announcement So Significant? 

By now purchasing these bonds, the Bank of Canada is directly providing a powerful stimulus to the banking system and the real estate market. If Banks can now profitably sell mortgage bonds to the central bank, it is likely that their incentive to further increase mortgage debt will rise. This could have a negative impact of the quality of bank underwriting, and will provide a boon to housing prices by facilitating higher demand.
Tembo will keep an even closer eye on the Bank of Canada, this news signals that simply watching rates is not enough. This added central intervention into market brings more risk to Canada’s housing system. You heard it here first.

Are Further Rates Hikes Coming?

Another blog, another rate hike. The BOC (Bank of Canada) announced on Wednesday that its overnight rate would be increased from 1.50 to 1.75%

This is the fifth increase in rates in the last year and a half. As Tembo has repeatedly mentioned, a stable economy and good stats would lead to the BOC increasing rates – this is the signal they’ve been consistently sending for some time now. Rates are now back to where they were in late 2008, right before the last financial crisis.

Bank Of Canada Plays It Safe

The Bank made several comments and offered rationale for its decision. The conclusion of trade uncertainty with the United States and Mexico with the signing of the USMCA was cited. As was strong economic data (job growth, GDP growth, low unemployment). In the words of experts, with the economy in such decent shape, stimulus in the form of low interest rates is not needed. Increasing rates also serves the goals of policymakers in Ottawa and Toronto who want less credit available to heat the property markets. As we’ve mentioned in previous blogs, the Bank is following international counterparts in raising rates. 

What Does This New Hike Rates Mean For You?

We want to make two points in this blog in response to this increase. One, it will result in higher overall borrowing costs and it will make mortgages more expensive. And two, that rates are still extremely low. Even in the medium term, rates will be at historic lows. Please see the attached graphic from the Bank of Canada to see the objective picture of rate movements in the last 11 years. In addition, Tembo recommends its readers prepare their finances for higher borrowing costs.

A Positive August For Real Estate

Numbers reveal a positive August for GTA real estate and welcome figures for an industry that had a relatively cool summer selling season.

 

August real estate

In Toronto, sales increased by 8.5% and prices were up 4.7% from a year ago. The average price for a home is now roughly $764,000 dollars. Although nowhere near early 2017 highs, the market is showing its resilience and demand despite all the battering it received over the past year.

New listings increased by 6% and the overall number of active listings increased by 9%, showing many new sellers joining the market and feeling positive about their capacity to get good prices for their assets. General media sentiment on the figures was positive, with many remarking that the figures show a market that is rebounding, on positive footing, and in good overall shape.

On Interest Rates And The Bank Of Canada

The Bank of Canada maintained its existing rate of 1.50%. There was no increase, which some expected, largely due to uncertainty over a trade deal with the U.S. and the potential implications and affects on the economy of a bad deal.

As Tembo has noted there is a risk of the U.S. placing tariffs on the Ontario economy and Canada’s forced departure from NAFTA. Such an outcome would devastate Ontario’s economy, whose backbone is automobile assembly and its associated spin-off industries and supply chain. Core inflation exceeded the Bank’s target of 2% and is at 3%. 

The Latest Trade Negotiation News With The U.S.

Chrystia Freeland

Canadian Foreign Minister Chrystia Freeland, speaking with reporters outside the U.S Trade Representative building in Washington D.C.

The Prime Minister has stated that there will be no NAFTA deal with the U.S. unless Canada’s cultural industries (arts and broadcasting sectors) are protected. The PM is worried U.S. media conglomerates or companies could buy a Canadian newspaper or TV station. In addition the Prime Minister wants a dispute settlement clause included to to “ensure the rules are followed.” President Trump has tweeted that a deal with Canada is not a ‘necessity’ and he has repeatedly warned that he could easily exclude Canada from a deal if tariffs on Canadian dairy and eggs are not eliminated.

Another Rate Hike Is Coming

July’s inflation figures are up to 3%, the biggest monthly increase in over 7 years as prices for gasoline and and air travel increased sharply.

Interest Hike Hike Coming

Bank of Canada Could Increase Rates By Another 0.25%

Tembo has consistently reminded its readers and clients that the Bank of Canada is very mindful of inflation and watches it carefully. The Bank is internationally renowned for keeping inflation in and around its benchmark target of 2%. This sudden spike in inflation is likely to increase pressure on the Bank to raise its rate by another quarter percentage point. 
 
This recent increase in inflation comes at a time when the economy has been growing strongly and the Bank has continued its policy of increasing rates in tandem with Central Banks around the world. Canada’s mortgage banking rates are still very low by historical standards, and will remain low even as they respond to likely rate hikes by the Bank of Canada. On a separate note, real estate figures in Montreal and Toronto are improving and warming up. 

New Construction Heating Up

In addition, the latest CMHC figures show that construction starts (both condo and houses) are increasing across the country, from small municipalities to the City of Toronto. On a final general update on real estate, polling shows that the biggest political issue for Millennials is the affordability of housing, given the astronomically high average prices for real estate in the country – even after recent cooling measures.

How Are Interest Rates Set

In this week’s blog, Tembo Financial will outline how interest rates are set in Canada and the United States. 

bank of canada

Rate setting by the Bank of Canada (BOC) and the Federal Reserve (Fed), most impact Canadian and GTA real estate. 

In Canada, the Bank of Canada’s interest rate is set by the Governing Council, a team of three Deputy Governors, the Deputy Governor, and Governor Stephen Poloz. 
Stephen Poloz
Image Caption: Bank of Canada Governor Stephen Poloz. 
Similarly, in the United States, the interest rate is set by the Federal Reserve’s Open Market Committee (FOMC). The FOMC is a Committee made up of senior officers of the Fed including the Fed Chair and Governors. The rate is deliberated upon by the FOMC, generally the Committee must come to a consensus agreement on the rate and the general direction of monetary policy. Each member of the Committee has the authority and opportunity to express his or her views on the state of the economy and their opinion on where the rate should go.
The FOMC is independent. It does not answer to the President, the Congress, or any public organ of U.S. power. The Federal Reserve is not audited by Congress, and is fiercely protective of its independence, privileges, and powers. It is arguably the most powerful socio-economic institution on the planet. 

Further Rate Hikes Are Coming

Tembo Financial reminds its viewers that interest rate trajectories will remain upward as long as the economy remains stable. Expect and prepare for rate hikes.

Bank of Canada Hikes Rates

The Bank of Canada to increased rates at its decision meeting on Wednesday, July 11th. The central bank increased its key rate to 1.5 per cent from 1.25 per cent.

bank of canada picture

The forces that favoured an increase in the cost of money outweighed those that supported continued loose money policies. The Canadian economy remains in very good shape. Inflation hasn’t reared its ugly head, household consumption is neither increasing recklessly nor falling precipitously. Growth and unemployment figures are very positive. Lack of price growth dynamism in the real estate markets, trade issues with the United States, and high levels of private and public debt are the key structural problems. Weighed against one another, the balance skews toward a rate hike.

Central Banks Around The World Are Adamant.

Central banks have begun and will continue a long term policy plan of ever higher rates, and more scrutiny on international banks and financial institutions. The Bank of Canada is no different. The key facts that most worry senior officials, politicians, and Central Bankers are the enormous levels of household and government debt, particularly mortgage debt. A generation of historically unprecedented record low interest rates has blown up large debt bubbles which elites are now desperate to deflate as carefully as possible.

Rates Hike To Negatively Impact Consumers

The likely hike will no doubt have a negative impact on consumers and on the real estate market. Banks are likely to raise their mortgage rates in response. The debt to disposable income ratio in Canada has hit a record of almost 175%, much higher than in the United States before the start of the Great Recession. A rate hike will be of no help to those looking for high prices for their real estate holdings. Debt to income ratios for the poorest Canadians are especially high. The lowest quintile of earners average a debt ratio of almost 350%. While higher rates will come at a cost, many believe they are absolutely necessary, and few doubt they are avoidable.