The Bank of Canada raised interest rates another 50bps this past week, signalling more pain to come. The overnight rate sits at 150bps, just shy of where the Bank of Canada got stopped out in 2019. Markets are still pricing in another 150bps of additional tightening this year, which suggests the overnight rate will sit at 3% by year end, which remains overly optimistic in my view given the debt loads not just in Canada, but around the world. Global debt to GDP sits at 365%. For further context, there’s about $30 Trillion of debt in the US alone, so a 1% increase in interest rates adds about $30B of extra interest costs, about half the annual defence budget. Suffice to say, policy makers have some difficult decisions ahead.
For now the domestic housing market is adjusting rather quickly. In May, Greater Toronto home sales plunged 39% year-over-year, 31% in Greater Vancouver, and a whopping 54% in the suburbs of Vancouver (Fraser Valley). This shouldn’t be surprising given the abrupt change in financing costs over the past 3-4 months. Home buyers are waiting for prices to adjust lower to at least partially offset rising borrowing costs.
Let’s run some simple numbers here. The benchmark price of a home in the Fraser Valley sits at $1,167,300 as of the end of May. Assuming 80% LTV, on a 30 year amortization and a 5 year fixed mortgage, at current rates of 4.5% that equates to a monthly payment of $4709. Run the same math but assume your mortgage rate is 2.5% which was the going rate just 4 or 5 months ago and that equates to an extra $1025 per month on your mortgage payment. In other words, you’re getting the same house as before but you get the luxury of paying an extra thousand dollars per month. Most suburban families don’t have an extra thousand dollars a month kicking around, now add in rising fuel and food prices and its not hard to understand why sales volume has been cut in half.
Following the rate hike announcement, deputy governor at the Bank of Canada suggested they may have be even more forceful on rate hikes, although they are seeking a “soft landing” between slowing inflation and hammering the economy into a recession. The idea of a soft landing is rather wishful thinking. They basically have to kill enough demand to bring commodity prices (energy) down, without triggering a financial mishap, which seems increasingly unlikely given the debt loads we mentioned earlier. Remember, the largest borrower in recent years has been the Canadian Government. Between 2020-2021 the Canadian Government grew their debt by $345B, a 45% increase on total debt outstanding in just a twelve month period. Feel free to run the increase in interest costs on that as rates triple.
It seems central banks want to have their cake and eat it too, ie bring a 30 year high in inflation back down to 2% while somehow not destabilizing the record debt loads we’ve accumulated over the past 30 years. Pour one out for the soft landing, god knows we’ll need it.
Three Things I’m Watching:
1. Ownership transfer costs in Canada (Realtor fees) is nearly as large as all expenditures on machinery/equipment and R&D across all industries per Stats Canada. (Source: Ben Rabidoux)
2. Canadians added $190B of mortgage debt over the past twelve months. (Source: Richard Dias)
3. In the US, 19.1% of home sellers dropped their price in the past four weeks, up from 13.0% a month earlier and 9.8% a year ago. Highest share since October 2019. (Source: Redfin)
