Euthanizing the Bond Market

Steve Saretsky -

Last week we discussed the ongoing dispute in New Zealand, where the finance minister has been arguing with the head of the central bank to consider house prices in their central bank monetary policy framework. Like nearly everywhere else in the world, New Zealand is grappling with a severe housing affordability crisis. Despite pulling numerous policy levers, house prices continue to inflate. The last lever, raising interest rates, remains off the table.

Things have only gotten worse during the pandemic. “We’ve probably seen the biggest widening of wealth distribution that we have ever seen in New Zealand between people who own houses and those who don’t,” said Arthur Grimes, professor of public policy at Victoria University of Wellington. According to the Real Estate Institute of New Zealand, the median house price in New Zealand has surged nearly 20% this year.

Ironically, in 2018, new elected Prime Minister Jacinda Ardern fulfilled her election promise of banning sales of residential housing to foreign buyers. Clearly that wasn’t the solution.

New Zealand’s problems are not unique. The same discussions are ongoing in Canada. Home prices are up double digits this year, despite record job losses. The wealth gap continues to widen, prompting the Trudeau Government to lobby for a national foreign buyers tax. If Vancouver & Toronto are any example, that too will fail to improve affordability.

The reality is, the only way to improve affordability is to raise interest rates. Sure, you can build more homes and that will help slow the rise in home prices. But consider this. Whether you agree with it or not, central banks have artificially suppressed interest rates in order to aide in a recovery and spur economic growth. However, by effectively euthanizing the bond market, a $128 trillion dollar asset class, these dollars have to go somewhere, and they are funnelling into real estate.

Is it really that surprising that investors are ok with negative cash flowing condos when most government bonds yield less than 1% today? If held to maturity these bonds are a guaranteed loss when you consider that most central banks are targeting annual inflation of 2%.

Unfortunately central banks have found themselves in a difficult situation, cornered into a zero interest rate policy that becomes impossible to exit. The solution seems to be a full nationalization of the entire bond market. The Bank of Japan has been doing this for decades, and now own nearly 50% of the entire Japanese government bond market. Canada has been aggressively playing catch up, with the Bank of Canada inching closer towards 35%.

It seems any pick up in yields will be met swiftly with more central bank purchasing, and yield curve control. A policy measure that dictates the price of money, not through free markets but through central planning.

A subtle reminder there is no such thing as a free market. Things can always get crazier. Heck, in Denmark, they are giving out 20 year mortgages at 0%.

Three Things I’m Watching:

1. Canada’s labour market hits the skids, losing 62,000 jobs in December as the recovery stalls.

2. Home prices in the Greater Toronto Area jumped 10% y/y in December. (Source: Realosophy)

3. Falling mortgage rates have been a boost to buyer demand. (source: Capital Economics)



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