Globe and Mail July 15 2017
Barrie McKenna and David Parkinson
Barrie McKenna an David Parkinson
From Ottawa to Frankfurt, central bankers are starting the complex process of unwinding a series of emergency measures put in place to deal with the Great Recession. The shift in policy could take years to play out, and will have a profound impact on lenders, savers, borrowers and investors. There will be winners — and losers, write Barrie McKenna and David Parkinson
Nearly a decade after the easy money era began, the great unwinding is finally under way. How the world’s central bankers are preparing for a delicate balancing act as years of interest-rate hikes loom – and why lenders, borrowers, investors and savers are on the edge of their seats. Barrie McKenna and David Parkinson report
From Ottawa and Washington to London and Frankfurt, central bankers are gingerly dismantling the emergency measures they put in place to deal with the aftermath of the 2008 financial crisis and the Great Recession
It’s not often the world’s financial markets pay rapt attention to the deliberations of Canada’s central bank.
This week marked one of those rare moments as the Bank of Canada announced a modest quarter percentage-point rise in its key interest rate – its first rate hike in seven years.
It’s not that traders in London and Hong Kong care what the future holds for Canadians on fixed incomes or those stuck with big variable-rate mortgages and crushing debt loads. Nonetheless, they were watching events in Ottawa this week with unusual interest, seized by a sense that the world has reached a tipping point, where the costs of low rates are starting to outweigh the benefits.
In the rear-view mirror lies an unprecedented era of easy money. Ahead looms a future of steadily rising interest rates, not just in Canada, but globally.
And so it was big news that a G-7 central bank would suddenly flip the switch from loose monetary policy to tightening, without a whiff of inflation in the summer air. Tired of waiting for a spike in consumer prices, inflation-fighting central banks everywhere are suddenly looking at how to get out of the rut they’ve been in for nearly a decade – flooding the global economy with liquidity through ultralow interest rates and relentless bond buying.
“This is a really important turning point, not just for the Canada story, but for the global rate story,” explains Frances Donald, senior economist at Manulife Asset Management in Toronto. “Central banks seem to be saying, collectively, that they don’t expect inflation to get back to target. But they realize they can’t keep rates at emergency levels forever. It’s a tacit admission that low rates can’t solve all of the world’s problems. In fact, they may be exacerbating them.”
From Ottawa and Washington to London and Frankfurt, central bankers are starting the complex process of unwinding a series of emergency measures they put in place to deal with the aftermath of the 2008 financial crisis and the Great Recession. They realize these policies have hung around, increasingly uncomfortably, for much longer than anyone had anticipated.
The way forward creates a delicate balancing act for the world’s central banks. Higher interest rates will inevitably cause stress, particularly in pockets of the global economy where cheap money has created bubbles. Canada is just one of several countries that have witnessed sharp runups in real estate prices. There are also concerns that too much borrowed cash has flooded into bonds, emerging markets and even some infrastructure projects – investments that could now crumble in a rising rate environment.
One of the legacies of low-forlong interest rates is the potential for a dangerous debt hangover. Global debt as a share of GDP reached a record high of $217-trillion (U.S.) in early 2017, reaching 327 per cent of the world’s GDP, according to the Institute for International Finance. That’s higher than it was before the financial crisis, driven by a combination of consumers, businesses and governments feasting on low rates. The shift in policy could take years to fully play out and will have a profound impact on lenders, savers, borrowers and investors.
The past decade has been a remarkable learning experience for central bankers. They exposed us all to the exotic world of negative interest rates, quantitative easing and financial engineering. The consensus of experts is that these extraordinary measures were necessary, saving the global economy from financial ruin. But all that easy money, including lowfor-long interest rates, was not without cost. And the unwinding process will not be without pain.
Canadians who live in Toronto, Vancouver and other hot housing markets know all too well what low interest rates have done to the cost of homes and to urban skylines. Million-dollar fixeruppers, mushrooming condo towers and home buying bidding wars are all part of the legacy of easy money.
On the flip side of the low-interest-rate problem, savers are also feeling the unpleasant side effects of near-zero interest rates. There are people on fixed incomes struggling to get by and pensionfund managers scrambling to generate adequate returns to meet generous promises made to retirees.
Investors have poured cash into stocks, corporate bonds, real estate and emerging markets – all in the pursuit of higher yields in a low-rate world.
Perhaps most troubling for Bank of Canada Governor Stephen Poloz and other central bankers is that easy money has not magically produced the robust economic recovery everyone hoped for. Instead, Canada and other countries have experienced a frustrating series of false economic starts since the last recession. Key economic drivers, such as business investment and exports, remain weak and inflation continues to fall in many countries.
“There has been a general belief that central banks can save the day, and the past few years are a great example that there are limitations to monetary policy,” explains McGill University economist Christopher Ragan, a former special adviser at the Bank of Canada.
One of the lessons learned in Canada is that interest rates are a blunt instrument to deal with events such as the commodities shock in 2014 and 2015, when the price of crude plunged 50 per cent. The Bank of Canada responded with two quarter-point “insurance” rate cuts in a bid to ease the hit to the broader economy.
The rate cuts accelerated the decline of the already falling Canadian dollar. While that was good for exporters, it has inflated the cost of imported goods for consumers and businesses. Low rates also encouraged consumers to load up on debt – to buy cars, furniture, electronics and the largest personal expenditure of all: homes.
“The aftermath [of low rates] was to take an already hot housing market and throw kerosene on it,” Bank of Nova Scotia economist Derek Holt complains. “One of the reasons we’ve had supercharged growth for several quarters now is because we have applied excess stimulus – both
This is a really important turning point, not just for the Canada story, but for the global rate story. Central banks seem to be saying, collectively, that they don’t expect inflation to get back to target. But they realize they can’t keep rates at emergency levels forever. It’s a tacit admission that low rates can’t solve all of the world’s problems. In fact, they may be exacerbating them. Frances Donald Senior economist at Manulife Asset Management monetary and fiscal.”
The Bank of Canada would have been wiser to let the dollar drift lower on its own, easing the pain of lower revenues from oil exports, according to Mr. Holt.
Mr. Poloz would dearly love to get back to a normal world, McGill’s Mr. Ragan says. In that world, inflation would be on target at two per cent, growth would be steady and workers would be seeing their wages rising. And most importantly, interest rates would be firmly neutral, neither stoking excessive borrowing nor deflationary pressures.
“He wants to get back to normal,” Mr. Ragan says.
There is now a growing consensus among central bankers – Mr. Poloz among them – that the time has come to start scaling what was clearly intended as emergency stimulus. The U.S. Federal Reserve has led the way with a few modest rate hikes and a promise this week from Fed chair Janet Yellen to shrink the central bank’s $4-trillion (U.S.) balance sheet in a “slow, gradual, predictable way,” likely starting later this year.
In Britain, Bank of England Governor Mark Carney has hinted at a possible rate hike. Even European Central Bank head Mario Draghi, the most enthusiastic user of unconventional monetary policy, endorsed the shifting mood when he mused recently that “deflationary forces have been replaced by reflationary ones.” Even China is in tightening mode.
“The unwinding of monetary stimulus is significant, especially if central banks are jumping the gun,” economist David Andolfatto, vice-president of research at the Federal Reserve Bank of St. Louis, said in an interview this week. “If central banks guide their decisions through the lens of conventional theory, then raising interest rates is contractionary and disinflationary. Given the present [weak] measures of real economic activity and inflation, it’s not entirely clear why central banks are suddenly so keen to embark on a tightening cycle.”
Former Bank of Canada Governor David Dodge sees it differently. He says the world put too much faith in monetary policy to carry the global economy in recent years, without the help of government spending. Rates have stayed too low for too long, creating dangerous distortions in asset prices.
“It’s not a question of should we be going up [with rates], but how late are we in doing that,” Mr. Dodge argues.
The unwinding won’t be easy. Interest rates remain ultralow – negative even – after you factor in the rate of inflation.
Global central banks have swollen their balance sheets, scooping up mortgage bonds and other assets in an effort to create liquidity in financial markets artificially. Those assets have swelled to $19-trillion – roughly the size of the U.S. economy – from $3-trillion in 2000. And every month, the ECB and the Bank of Japan add tens of billions of dollars more in assets to their balance sheets.
A sudden move to sell those assets by Ms. Yellen or Mr. Draghi would send long-term interest higher and shock waves through financial markets. No one wants a repeat of the 2013 “Taper Tantrum,” when the Fed first mused about scaling back its bond purchases.
“You have to watch the pace in which you unwind [central bank balance sheets],” says Steven Ambler, professor of economics at the Université du Québec à Montréal. “If you dump all this stuff on the market at once, it will be hard for the private sector to absorb.”
As this unwinding progresses, central bankers in Canada and elsewhere will have to figure what to do about inflation – or rather, its mysterious absence. Inflation has become the most persistent and frustrating riddle of the low for-long rate era. Over the past quarter-century, the use of a clearly identified inflation objective as a critical guide for setting interest rates has become a widely accepted practice among the world’s leading central banks. (A 2-per-cent target, which the Bank of Canada has relied on for more than 20 years, is pretty much the accepted standard today.)
But in many economies now talking about unwinding their substantial monetary stimulus, the inflation target remains stubbornly elusive – despite years of low rates that were pretty much designed to reinflate the economy. Indeed, that’s the whole point of inflation targeting – to apply interest rates to steer the inflation rate toward the target. By extension, a near-target inflation rate is supposed to imply an economy generating relatively healthy and stable growth. (This relationship between inflation and the broader economy is known in economics circles as “the divine coincidence”; it is the very backbone of inflation-targeting monetary policy.)
Economists generally agree that extreme low rates successfully staved off a deflationary spiral during the depths of the 2008-09 financial crisis – and in doing so, averted a full-blown depression. But after the better part of a decade on the job, they have failed to revive inflation. Indeed, when central banks cut their rates to the bone, and even introduced quantitative easing in the wake of the crisis, many critics feared that, in their zeal, they would unleash an inflation storm; we’ve seen nothing of the sort.
Even as economies accelerate, inflation has continued its persistent lag. And most disturbingly, there are virtually no wage pressures, even in areas where there are skills shortages. Canada’s inflation rate is a tepid 1.3 per cent, as is the euro zone’s. In the United States, where the Fed has raised its key interest rate three times in the past eight months, the core inflation rate was a modest 1.6 per cent in June. Japan’s inflation rate is a puny 0.4 per cent.
The reasons for why inflation is so weak are myriad and complex. The most obvious recent factor is the collapse in the price of oil and other commodities, whose effects filter throughout the global economy. Global trade, the emergence of new markets and technological change have also made it easier and cheaper to make things. Finally, populations in the developing world are greying, slowing the growth of the labour market. All this creates what economists call “slack,” or an excess of labour and factory capacity.
“I don’t think [ultralow rates] did what they were supposed to do. If they were supposed to get inflation back up to more or less target rates around the world, it has not been successful,” UQAM’s Prof. Ambler says.
“Part of the job of monetary policy was to prevent booms and recessions in the real economy, and inflation targeting was supposed to be a means in part to achieving that end. It didn’t work,” adds Nicholas Rowe, economics professor at Carleton University in Ottawa.
In the short run, central bankers face the kind of decision the Bank of Canada did this week: whether to forge ahead with monetary tightening, despite the lack of an imminent inflation signal.
Mr. Dodge thinks central banks should set aside inflation targeting temporarily and commit to gradually lifting interest rates from their current extreme lows to something approaching “normal” levels.
“There’s an argument to say, ‘We’re going to move those rates up to, say, 2 per cent, and we’re going to move them up in a slow and deliberate fashion, and we’re going to tell you ahead of time.’ So that there need be no panic and no uncertainty as to what is going to happen. Without having some understanding of how fast and how far you’re going to move, there’s a danger that markets become unsettled,” Mr. Dodge says.
In the longer term, central bankers will have to confront a much bigger question: Whether they’ve put too much faith in inflation as an anchor for monetary policy.
“I think the inflation target itself has taken a hit,” Prof. Rowe says. “The 2-per-cent inflation target needs to be looked at. It didn’t turn out to be as good a thing to target as some of us thought it would be.”
There is no shortage of ideas out there to replace the 2-per-cent target. Some economists believe central banks need a higher target, say 3 per cent, to reset inflation expectations and create more breathing room from the bottom for both inflation and, by extension, interest rates. Others think central banks would be better off targeting a price level rather than an inflation rate, so slowdowns in inflation would be offset by policy aimed at temporarily higher inflation to return prices to their original growth path. Still others think that targeting growth in nominal gross domestic product – an indicator that essentially combines real economic growth and inflation in one package – is the solution.
“There are more questions being raised as to whether targeting domestic inflation is as appropriate as it was 20 years ago,” Mr. Dodge says. “I don’t think any central bank really has a definitive answer to that. We’re all a little bit puzzled, quite frankly.”
And Mr. Dodge feels for Mr. Poloz, Ms. Yellen, Mr. Draghi and the others. “This is a challenging time for central banks everywhere,” he says.
As interest rates rise, beware the Great Doldrums ahead
The Globe and Mail
Published Friday, Jul. 14, 2017 5:20PM EDT
Last updated Friday, Jul. 14, 2017 7:33PM EDT
Thanks in large part to seven years of rock-bottom interest rates, many investments around the world are shockingly expensive. From Canadian homes to U.S. stocks to European bonds, asset prices teeter at historic highs.
So what comes next? Most of the world’s major central bankers – including the Bank of Canada – have delivered unusually uniform messages in recent weeks, pointing to higher rates ahead.
Everything else being equal, a global move to higher rates is likely to start pressing down on asset prices over the coming year, in much the same way as lower rates after the financial crisis provided a powerful push upward.
It’s easy to sketch a nightmare scenario in which central bankers jerk on the rate lever too fast, toppling housing markets and stock prices into the ditch and bringing about a new crisis.
More likely, though, is for rates to inch higher in a slow, cautious crawl. Our monetary overlords know the risks of being too aggressive.
They will want to avoid setting off a new emergency even as they attempt to bring rates back to more normal levels nearly a decade after first slashing them.
Exactly how this move to higher rates will work out is open to conjecture. Never before have the world’s central banks had to normalize their economies after an extended period of what Andy Haldane, chief economist at the Bank of England, reckons to be the lowest interest rates in 5,000 years.
For now, one scenario that many people appear to be willfully ignoring is the prospect of a Great Doldrums – a situation where rates rise but asset prices do little or nothing for several years to come.
For workers, this could be pleasant. Homes would gradually become more affordable; stocks, too. Savings accounts might even start to provide a reasonable return, while higher rates on GICs and bonds would benefit retirees with large fixed-income portfolios.
For other investors, though, the new era could come as an unwelcome jolt. A typical Canadian family, which has seen both its stock portfolio and home value soar in recent years, might have to buckle up for an extended period of much lower returns. That could be painful to people who are counting on big investment gains to finance their golden years.
Still, a long lull would be much easier for an economy to handle than a market crash. In fact, an extended pause would be the most painless way to reverse the effects of years of ultralow rates and bring asset prices back into line.
Consider real estate. Based upon the historical relationship between property values and personal incomes, Canadian home prices are overvalued by 30.5 per cent, according to the Organization for Economic Co-operation and Development.
So a decade in which real estate prices flat-lined while incomes grew at 3 per cent a year wouldn’t take the market into unfamiliar territory, but simply restore the traditional relationship between home prices and family paycheques.
Similar math holds true for the U.S. stock market, where many valuation measures point to frothiness. The Shiller price-to-earnings ratio, which compares current stock prices to corporate earnings over the preceding 10 years, hovers around 29, far above its historical average of 16.6. A flat decade for stock prices, coupled with steady growth in corporate profits, would go a long way to bringing that distorted ratio back into kilter.
To be sure, a long period of flat asset prices would be an historical anomaly, but if the past decade has taught us anything, it’s to be prepared for the unusual.
Nobody in 2007 foresaw an extended period of zero, or even negative, interest rates across many of the world’s developed economies.
Right now, a long period of flat asset prices would be the logical result of a standoff between tighter monetary policy and more ebullient growth.
Think of it this way: Central banks’ new willingness to raise rates amounts to a vote of confidence in the global economy. For the first time since the financial crisis, all major regions appear to be expanding at a decent clip.
As a result, central banks are eager to dial back the easy-money policies with which they’ve nursed sick economies back to health. This doesn’t have to be disruptive.
If investors conclude that the strengthening global economy is just enough to balance off the drag of tighter monetary policy, then there’s no need for asset prices to move much, if at all.
The danger is if central banks miscalculate and raise rates too fast or too slow. Some observers worry that years of low rates following the financial crisis have created financial imbalances across the global economy that can’t be easily reversed.
Among other things, near-zero rates have encouraged borrowers around the world to take out mammoth amounts of loans. According to the Institute of International Finance, global debt hit a record $217-trillion (U.S.) in the first quarter of this year, equivalent to 327 per cent of global gross domestic product.
“Financial markets will need to adjust after an exceptionally long period of dependence on ultra-easy monetary conditions,” the Bank for International Settlements warned in its annual report this past month. Among the most prominent dangers is that “the global economy is threatened by a global debt overhang.”
Another risk is a stock market collapse. GMO, a widely followed money manager in Boston, predicts that large U.S. stocks are set to lose roughly a quarter of their inflation-adjusted value between now and 2024 if markets revert to their historical valuations over the next seven years.
Losses of that magnitude would gut many pension fund assumptions, not to mention many personal portfolios.
Central banks know all of this, and will move cautiously to normalize their economies. “Expect a gradual reversal in yields that will play out glacially over many years,” says Tyler Mordy, of Forstrong Global Asset Management.
Expect, too, that this will not be an entirely smooth operation. Capital Economics notes that seven of the 11 central banks it covers have raised interest rates since 2008, only to subsequently lower them again when growth has disappointed.
The global economy appears to be on a more solid footing this time.
Still, “we suspect that the Bank of Canada will reverse [this week’s] rate hike next year, because we anticipate that the bubble in the country’s property market will burst,” Andrew Kenningham, chief global economist at Capital Economics, writes.
Brace for some bumps ahead.
Follow Ian McGugan on Twitter: @IanMcGugan
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Average payments on new mortgages rising faster than inflation: CMHC
TORONTO — The Canadian Press
Published Tuesday, Jun. 13, 2017 9:08AM EDT
Last updated Tuesday, Jun. 13, 2017 9:23AM EDT
Canada’s federal housing agency says the average scheduled monthly mortgage payment for new loans climbed to $1,328 in the fourth quarter of 2016, up 4.6 per cent from $1,269 a year ago.
The increase came as house prices continued to rise, particularly in the cities of Toronto and Vancouver and their surrounding areas.
Canada Mortgage and Housing Corp. says the fact that the average scheduled monthly payment is growing faster than inflation is concerning because it suggests that homeowners could struggle to make their payments going forward.
In Toronto, the average payment was $1,826 during the fourth quarter of last year, up 11.5 per cent from $1,638 a year prior.
In Vancouver, it rose by 4.5 per cent to $1,936 from $1,853 in the fourth quarter of 2015.
CMHC, which obtained the data from credit monitoring agency Equifax, says mortgage delinquency rates during the fourth quarter of 2016 were 0.34 per cent nationwide compared with 0.35 per cent a year earlier.
UPDATED WEDNESDAY, JUN. 14, 2017 3:55PM EDT
House prices see record gains in May
House prices rose by a record 2.2 per cent across Canada in last month compared to April, led by a 3.6 per cent price increase in Toronto even as total sales fell during the month, Teranet reported Wednesday.
The index recorded the largest May gain in its 19-year-history, reaching another record high for the 16th consecutive month. Prices were up in May over April in all 11 major markets included in the index.
National prices were up 13.9 per cent over May last year, coming close the record annual price gain of 14.1 per cent recorded in September, 2006.
National Bank economist Marc Pinsonneault said the data suggests new housing measures introduced by the Ontario government in April may have dampened sales and boosted new listings, but the impact on home prices “remains to be seen.”
The strength of the Canadian market is clearly driven by Victoria, the GTA, Hamilton, and other regions in Ontario in the “golden horseshoe” area surrounding the GTA, he said, which all have double-digit year-over-year price gains.
— Janet McFarland
Below you’ll find house price data for the most recent month, including any recent change in prices, the current average house price, and the long-term trend for Canada’s biggest cities. Select a city next to the graph to see how it compares to the others.
National house prices for May 2017
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THE NEXT MOVE
Is it a blip, or is the GTA housing market on the verge of severe correction?
The Globe and Mail
Published Thursday, Jul. 13, 2017 8:02AM EDT
Last updated Thursday, Jul. 13, 2017 1:55PM EDT
Is the recent downturn in the Greater Toronto Area’s real estate market a blip or the start of a severe correction?
John Andrew, a professor at Queen’s University and executive director of the Queen’s Real Estate Roundtable, is calling it a blip. He expects strength to return to the market after prospective buyers get their heads around the Ontario government’s recent policy changes. But the business professor cautions there are risks to his prediction.
One is the spectre of rising interest rates. This week, the Bank of Canada hiked interest rates for the first time in seven years when it lifted its benchmark rate by 25 basis points to 0.75 per cent. The move was widely expected by financial markets.
This week, the Bank of Canada hiked interest rates for the first time in seven years when it lifted its benchmark rate by 25 basis points to 0.75 per cent. The move was widely expected by financial markets.
Prof. Andrew warns that a series of rate hikes in Canada would put pressure on a lot of households – especially in Toronto and Vancouver, where many people hold massive mortgages. Another factor is the level of trepidation buyers already appear to be feeling after Ontario’s introduction on April 20 of a tax aimed at foreign buyers.
“What a quick transition we’ve seen from a very strong sellers’ market to a very strong buyers’ market,” Prof. Andrew says of the abrupt decline in sales.
Data from the Toronto Real Estate Board show sales plunged 37.3 per cent in the GTA in June compared with the same month last year. New listings last month jumped 15.9 per cent from June, 2016. That tally follows a topsy-turvy May, when sales dropped 20.3 per cent compared with a year earlier and new listings skyrocketed 48.9 per cent for the same period.
The swell of new listings subsided in June after May’s surge, but that’s partly because June traditionally marks the end of the spring season, when the number of people putting their properties on the market tends to dwindle.
But the GTA market has been in a skid since the Ontario government introduced a slate of new measures aimed at taming runaway price growth. After a blistering first quarter, the province launched a 15-per-cent tax on non-resident speculators who purchase property in a part of Ontario known as the Greater Golden Horseshoe.
The measures appear to have spooked buyers, but even in the weeks leading up to the announcement, some buyers were becoming hesitant about venturing into such a zany market.
Prof. Andrew believes the foreign-buyers tax is the most significant factor in pushing buyers to the sidelines.
Last week, the Ontario government reported that 4.7 per cent of homes purchased in the Greater Golden Horseshoe between April 24 and May 26 were by foreign buyers.
“It’s not a very significant number that are being bought by foreign investors,” Prof. Andrew says. “But it has changed buyer psychology and that’s all it takes.”
He says there is not a lot of objectivity or rationale for the market responding as it has, which bolsters his belief that people were just looking for an excuse for the market to cool off.
He believes the percentage reported by the province is a flimsy reason for the market to tank because the tally is not all that reliable. The data were collected over only a few weeks. There’s also a relatively high degree of error in such reports, he adds, and they tend to skew on the low side.
A more thorough breakdown of the numbers obtained by The Globe and Mail this week confirms that certain pockets in the Toronto area have much higher rates of foreign investment.
Prof. Andrew adds that it’s difficult for the government and industry to know who the actual buyer of a property is. There are various loopholes and exemptions that allow overseas investors to get around the tax, he adds.
People exempt from paying the tax include immigrants who either have or are seeking permanent-resident status, and foreign students studying in Canada.
“That’s a no-brainer. That’s quite an exemption,” Prof. Andrew says of the international-student status. “These are sophisticated investors, and who doesn’t want to get a Canadian university or college education anyway?”
John Pasalis, president of Realosophy Realty Inc., thinks the province’s numbers need some context. He notes the data were based on deals that closed – that is, ownership was transferred – between those dates. Mr. Pasalis points out that closing the deal typically happens 60 days after a home is sold. He reckons the majority of these sales took place before the province introduced the non-resident speculation tax.
Also, while the data cover the Greater Golden Horseshoe, most foreign buyers are zeroing in on the GTA. The numbers obtained by The Globe this week back up Mr. Pasalis’s view that the 416 area code and parts of York Region, such as Richmond Hill and Newmarket, have pockets that attract large numbers of deep-pocketed overseas investors.
Mr. Pasalis adds that even 4.7 per cent is meaningful in a market where prices were rising by as much as 33 per cent on an annual basis in the first quarter. Homes purchased in the first quarter required 72 per cent of the average local household’s income to cover the carrying costs.
Looking ahead to the fall, Prof. Andrew will be interested to see what the central bank does at its next policy meeting.
“Certainly, the Bank of Canada is very disciplined in not responding to the real estate market,” he says, noting that the bank remains focused on keeping inflation in check. He adds there are real estate markets in Canada that don’t need cooling off.
But he figures if the central bank were to raise rates two or three times, housing markets across the country would slump.
“By about the second increase, the response will be ‘the gravy train has stopped.’ I think we would see a decline in house prices right across the board.”
In that scenario, Prof. Andrew’s biggest concern is what happens when homeowners’ mortgages come up for renewal.
Those with a five-year fixed-rate mortgage, for example, may be facing significantly higher rates when the five years are up. If consumers were stretched with rates below 3 per cent, they will be reeling if they have to renew a mortgage at 5.3 per cent, for example.
The problem is that employees’ income levels, on average, are not climbing. Those who took out a mortgage in 2016 or 2017 could feel a lot of pressure in 2020 or beyond.
“In a market like this, they borrow every dollar they can possibly borrow.”
Homeowners will find all kinds of ways to cut costs so they can stay in their principal residence, he says.
“They will go to Herculean efforts to not lose their home.”
His fear centres on the investors who own downtown Toronto condo units. In the current low-rate environment, those owners may be able to rent out the unit for $3,000 a month, which covers their mortgage payments and costs. But in a rising rate environment, carrying costs may shoot up to $4,000 a month. Even if the rent has risen to about the $3,300 level during the same period, the owner is no longer recovering expenses.
“Those are realistic numbers,” Prof. Andrew stresses. He worries about investors in that situation because their commitment quickly vanishes. Rather than be out of pocket every month while hoping the unit rises in value, the investor is more likely to sell and take any gains from the appreciation above the purchase price.
“A lot of investors will do the math at the same time and they’ll dump them.”
The panic would be compounded by the fact that so many buildings are reaching completion within a relatively short time of one another. That means those unit owners would also be renewing their mortgages at about the same time.
Prof. Andrew says those owners will drop the asking price quickly and repeatedly until the unit sells.
“They want out,” he says. “Investors like that tend not to be patient.”
United States News
Photographer: Zuraimi/RooM RF
These Are the U.S. Cities Where It Costs Too Much to Build
Regulations and sky-high land prices are scaring off apartment developers.
June 26, 2017 2:00 AM
The U.S. needs more new housing.
Existing homes are in short supply for both buyers and renters, from bustling coastal metropolises to smaller inland cities. Home seekers are bidding up prices and historically low ownership rates mean more people are renting, triggering fierce competition for leases. There are signs that rent growth is slowing—it’s just not slowing quickly enough.
A new report published by the National Multifamily Housing Council and the National Apartment Association—two trade groups for landlords—seeks to quantify just how much rental housing is really needed in cities across the U.S.—as well as how difficult it is for real estate developers to actually deliver.
The first chart seeks to quantify the demand part of the equation. It looks across metropolitan areas, estimating future homeownership rates, household formation, demand for second homes, and attrition of older units—among other factors.
Here’s some past and prologue: Between 2000 and 2015, New York has added 212,000 rental units in buildings that have at least five units, according to the report. While less than what the city needs between now and 2030, it’s at least in the ballpark. Dallas, however, has built 144,000 such units over the same period. This means, given the above chart, the metro will have to almost double the pace of construction to meet estimated demand.
The good news, such as it is, is that there’s not a lot of overlap between the cities with the most overall demand and the ones shown in the second chart, which combines measures of zoning regulation and availability of buildable land. In this way, it ranks where regulation and land costs are the most challenging to developers.
The bad news for cities on this chart is that rent is expensive all over. In seven out of 10 cities where it’s hardest to build, more than two-fifths of renters spend at least 35 percent of their income on rent. The worst on that count is Miami, where 54 percent of renter households spend more than one-third of their income to pay for housing.
Big apartment buildings aren’t the only type of housing stock that’s in high demand. The U.S. needs more small apartments, and more single-family houses, too, especially in West Coast cities that have seen rapid job growth but only a modest supply of new homes for sale.
Central Bankers Tell the World Borrowing Costs Are Headed Higher
June 28, 2017 10:52 AM June 28, 2017 5:01 PM
- Markets fluctuate on hawkish notes from Europe to Americas
- Weak prices still a challenge but policy direction seems set
Global central bankers are coalescing around the message that the cost of money is headed higher — and markets had better get used to it.
Just a week after signaling near-zero interest rates were appropriate, Bank of England Governor Mark Carney suggested on Wednesday that the time is nearing for an increase. His U.S. counterpart, Janet Yellen, said her policy tightening is on track and Canada’s Stephen Poloz reiterated he may be considering a rate hike.
The challenge of following though after a decade of easy money was highlighted by European Central Bank President Mario Draghi’s attempt to thread the needle. Financial markets whipsawed as Eurosystem officials walked back comments Draghi made Tuesday that investors had interpreted as signaling an imminent change in monetary policy “The market is very sensitive to the idea that a number of central banks are appropriately and belatedly reassessing the need for emergency policy accommodation,” said Alan Ruskin, co-head of foreign exchange research at Deutsche Bank AG.
The Federal Reserve has been setting the tone in the trend toward a re-normalization of monetary policy and Yellen gave no sign that her plans for tightening were changing, even as she acknowledged that some asset prices could be rising more than warranted by fundamentals.
“We’ve made very clear that we think it will be appropriate to the attainment of our goals to raise interest rates very gradually,” she said on Tuesday, amid asset valuations that are “somewhat rich if you use some traditional metrics like price-earnings ratios.”
Yellen was the only major central banker from developed economies who didn’t attend the ECB’s yearly conference in Sintra, Portugal, where her counterparts from the U.K. and Canada signaled they could soon be following the U.S. on the path of rate hikes.
Carney said on Wednesday that the BOE may need to begin raising interest rates and will debate a move in the next few months. His comments mark a shift in emphasis after he signaled last week that it wasn’t yet the time to start that process, a statement he clarified was his position as of when the officials last met on June 15. The pound jumped the most since April.
Bank of Canada Governor Poloz reaffirmed his tightening bias, pushing the Canadian dollar higher and almost doubling the market-implied chance of a hike at the central bank’s next decision on July 12.
“It does look as though those cuts have done their job,” Poloz said, according to the transcript of an interview with CNBC. “But we’re just approaching a new interest-rate decision so I don’t want to prejudge. But certainly we need to be at least considering that whole situation now that the excess capacity is being used up steadily.”
Bottom of Form
And while rate increases are off the table for the ECB until well after it eventually ends bond purchases, Draghi got a taste of just how difficult it will be to steer a course out of extraordinary stimulus without unsettling markets. His speech sparked a rally in the euro and bond yields on Tuesday, leading officials familiar with the central bank’s strategy to try to contain what they saw as an excessive market reaction.
Underpinning Draghi’s caution in signaling an exit is the fact that, while the euro-area recovery continues to strengthen, inflation is still weak and wages and investment increases remain subdued. That’s a factor also highlighted by Bank of Japan governor Haruhiko Kuroda, who unlike his counterparts is set to keep the foot on the pedal of monetary stimulus.
The BOJ has pushed central-bank activism further than its peers. After more than four years of massive bond buying and with inflation still far from its 2 percent target, the central bank has embraced an active control of the yield curve. Still, Kuroda admitted the liquidity glut hasn’t been enough to spur companies to spend more.
“Since the introduction of qualitative and quantitative easing, economic conditions have improved and firms have experienced record high profits,” Kuroda said. “However, firms are still cautious about increasing spending, including investment.”
FOR RELEASE AT 8:30 AM EDT, FRIDAY, JUNE 16, 2017 MONTHLY NEW RESIDENTIAL CONSTRUCTION, MAY 2017 Release Number: CB17-98 June 16, 2017 – The U.S. Census Bureau and the U.S. Department of Housing and Urban Development jointly announced the following new residential construction statistics for May 2017:
Privately-owned housing units authorized by building permits in May were at a seasonally adjusted annual rate of 1,168,000. This is 4.9 percent (±0.9 percent) below the revised April rate of 1,228,000 and is 0.8 percent (±1.1 percent)* below the May 2016 rate of 1,178,000. Single-family authorizations in May were at a rate of 779,000; this is 1.9 percent (±1.0 percent) below the revised April figure of 794,000. Authorizations of units in buildings with five units or more were at a rate of 358,000 in May.
Privately-owned housing starts in May were at a seasonally adjusted annual rate of 1,092,000. This is 5.5 percent (±11.9 percent)* below the revised April estimate of 1,156,000 and is 2.4 percent (±11.4 percent)* below the May 2016 rate of 1,119,000. Single-family housing starts in May were at a rate of 794,000; this is 3.9 percent (±10.4 percent)* below the revised April figure of 826,000. The May rate for units in buildings with five units or more was 284,000.
Privately-owned housing completions in May were at a seasonally adjusted annual rate of 1,164,000. This is 5.6 percent (±9.2 percent)* above the revised April estimate of 1,102,000 and is 14.6 percent (±10.9 percent) above the May 2016 rate of 1,016,000. Single-family housing completions in May were at a rate of 817,000; this is 4.9 percent (±11.6 percent)* above the revised April rate of 779,000. The May rate for units in buildings with five units or more was 335,000. 0 300 600 900 1,200 1,500 May-12 May-13 May-14 May-15 May-16 May-17 Thousands of Units
Builder Confidence Slips Two Points in July, Remains Solid
Builder confidence in the market for newly-built single-family homes slipped two points to 64 in July from a downwardly revised June reading on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI). It is the lowest reading since November 2016.
Members are expressing significant concerns over rising material prices, particularly lumber. This issue, along with other significant supply-side constraints (i.e. cost and availability of labor and land), continue to limit builders’ ability to increase production at a faster pace.
Derived from a monthly survey that NAHB has been conducting for 30 years, the NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.
All three HMI components registered losses in July but are still in solid territory. The components gauging current sales conditions fell two points to 70 while the index charting sales expectations in the next six months dropped two points to 73. Meanwhile, the component measuring buyer traffic slipped one point to 48.
Looking at the three-month moving averages for regional HMI scores, the Northeast rose one point to 47. The West and Midwest each edged one point lower to 75 and 66, respectively. The South dropped three points to 67.
Residential Construction Loan Growth at Smaller Banks Has Slowed
Residential construction loans held by banks have grown over the past 4 years. However, in recent quarters, growth in the stock of residential construction loans has slowed. The recent slowdown in residential construction loan volume largely reflects a deceleration in growth across smaller banks, those with assets below $10 billion. These banks hold the majority of the bank-held residential construction loan stock. After a slowdown in positive growth for four consecutive quarters, the volume of residential construction loans held by smaller banks shrank in the first quarter of 2017.
Previous analysis from NAHB found that residential construction loans held by banks have grown for 16 consecutive quarters. As of the first quarter of 2017, the volume of residential construction loans held at banks totaled $70.7 billion, up 74 percent from its low, $40.7 billion, reached in the first quarter of 2013, but 65 percent below its recorded high of $203.8 billion reached in first quarter of 2008*.
However, in recent quarters, growth in the stock of residential construction loans has slowed from its steadier growth rates between 2014 and the first 3 quarters of 2016. As shown in the figure above, quarter-over-quarter growth in the residential construction loan stock returned in the second quarter of 2013. Between the first quarter of 2014 and the third quarter of 2016, quarterly growth averaged 4.1 percent. However, in the fourth quarter of 2016 growth slowed to 1.5 percent and in the first quarter of 2017 growth in the volume of residential construction loans was 1.6 percent.
The recent slowdown in residential construction loans largely reflected a deceleration in the rate of growth across smaller banks, those with assets at or below $10 billion, while growth at larger banks, those with assets at or exceeding $10 billion, has been more sporadic. NAHB analysis has found that smaller banks, those with assets totaling less than $10 billion , hold the majority of the residential construction loans stock. In the first quarter of 2017, these banks, in aggregate, accounted for 62 percent of the residential construction loans on the balance sheets of FDIC-insured banks.
Over the first two quarters of 2016, growth in the residential construction stock at smaller banks slowed in each successive quarter while growth at larger banks first accelerated over the first quarter than slowed in the second. In the third quarter of 2016, residential construction loan growth at smaller banks continued to slow, but growth at larger banks accelerated again. Despite strong growth across larger banks over the first quarter of 2017 as well, residential construction loan growth overall remained low as the volume of residential construction loans held by smaller banks shrank.
* The residential construction loan data only go back to the first quarter of 2007.
Builders Starting to Report Shortages of Framing Lumber
For several years now, the recovery in single-family home building has been hampered by shortages of labor and lots. Availability of building materials, meanwhile, has not been much of an issue. But that may be starting to change.
In answer to questions on the May 2017 survey for the NAHB/Wells Fargo Housing Market Index, 21% of single-family builders reported a shortage of framing lumber. Although still well below the share currently reporting shortages of lots and labor, this nevertheless marks a clear movement on the building materials front since 2014, when no product or material was cited as being in short supply by more than 15% of builders.
That was still true for most building materials in the May 2017 survey. Next to framing lumber, the most widespread shortages reported in 2017 are for ready-mix concrete and trusses, with 14% of builders currently reporting shortages of each. The graph below shows all 23 materials and products listed in the 2017 survey, sorted in descending order of the reported shortages.
For nearly all of these materials and products, the recent history has been relatively stable, with the share of builders reporting shortages moving only a couple of percentage points between 2014 and 2017. Framing lumber is the single, notable exception. In 2013, it looked as though a problem with the supply of framing lumber was starting to emerge, but the situation subsequently eased. Only 8% of builders reported a shortage of framing lumber in July of 2014 and 7% in July of 2015. But then, the share more than doubled in May of 2017, to 21%—a post-housing recession high. The last time framing lumber shortages were as widespread as they are now was in October of 2004, at a time when the annual rate of housing starts was hovering around 2.0 million (compared to the current rate of about 1.1 million).
The rising share of builders reporting shortages of framing lumber is consistent with recent increases in prices for softwood lumber. It is virtually certain that an underlying factor contributing to the shortages and price increases is the ongoing softwood lumber trade dispute between the U.S. and Canada, including the duties on lumber imported from Canada levied by the Department of Commerce in 2017. NAHB analyzed the economic impact of these duties, the latest of which was announced on June 26, in a previous post.
Open Construction Jobs Fall in May
The count of unfilled jobs in the construction sector declined in May, falling to level below that recorded a year ago.
According to the BLS Job Openings and Labor Turnover Survey (JOLTS) and NAHB analysis, the number of open construction sector jobs (on a seasonally adjusted basis) stood at 154,000 in May. The cycle high was 238,000, set in July of last year.
The open position rate (job openings as a percent of total employment) for May came in at 2.2%. On a smoothed twelve-month moving average basis, the open position rate for the construction sector declined to a still elevated level of 2.6%.
The overall trend for open construction jobs has been increasing since the end of the Great Recession. This is consistent with survey data indicating that access to labor remains a top business challenge for builders. However, recent data indicate a slowing in the count of unfilled construction jobs, albeit at levels higher prior to 2016.
The construction sector hiring rate, as measured on a twelve-month moving average basis, increased slightly to 5.2% in May. The twelve-month moving average for layoffs was steady (2.7%), remaining in a range set in 2014. The recent increase in the quits rate, an indicator of labor market churn, slowed in May to a 2% rate.
Overall, the labor market for construction workers remains tight as it continues to expand. Home builders and remodelers added 115,600 job over the last 12 months, and industry employment has increased by almost 713,000 since the low point after the Great Recession. As housing starts continue to increase, more workers will be needed in the residential construction sector.