Is the Canadian housing market in a bubble? Is it about to precipitate an nationwide financial crisis? If so, what can, or should, the BoC do about it?
The mathematicians at Statistics Canada that produce the BoC’s CPI measures would like you to know shelter costs in BC and Ontario were up 1.4% and 2.7% respectively in 2016, and “owned accommodation” inflation in both provinces hasn’t cracked 3% since Strange Brew came out.
Why such a dramatic divergence in the official statistics and data from actual sales? National Bank had some great charts on this last month:
A report from the consultancy CD Howe identified this threat back in 2012:
“To calculate the owner-occupied housing component in the CPI, Statistics Canada uses a so-called user-cost approach…Assumed prices for dwellings rather than actual prices for houses, and the inclusion of a mortgage interest component, makes the CPI less sensitive than otherwise to housing price changes.”
The piece recommends that Statistics Canada construct and maintain, in addition to the current CPI, an inflation indicator based on a net-purchases approach. While the BoC has been asleep at the wheel on the subject, the folks at National Bank did it for them, constructing an index that mimics the US Case-Schiller index.
What is interesting here is that the price spike is indeed isolated to Greater Toronto and the area around Vancouver. When taking out those metropolitan areas, the remaining cities, which combined with smaller cities and rural areas have 2/3s of the population, have seen zero real price appreciation this decade.
With shelter costs 28% of the CPI index, you can see how incorporating this data would throw some sand in the gears at the BoC. Changing to that method would add 3.7% to the current CPI, bringing it to a tasty 5-handle. “Governor Poloz….Agustin Carstens from Banxico on line 2….ok, I’ll tell him you’re not here.”
Is this bubble a threat to the whole economy? The financial system continues to look resilient. Canadian banks are 1) big, relative to the scale of the bubble, 2) wicked profitable, and 3) better capitalized than in 2008:
Other financial metrics suggest there is much more resiliancy in the financial system than those in economies that have recently hit the pavement. And as much as I hate to cite Warren Buffett as a barometer, he did just throw a pile of money at Home Capital.
Another factor is that more immigrants are arriving — about 70% of which show up in Vancouver or Toronto. This, combined with the foreign buyers discussed on Monday, are creating a localized scarcity of housing.
I’ll spare you a ton of charts that show low uninsured loan/value ratios but a leveraged Canadian consumer…no smoking guns there — in my opinion they suggest an inevitable, but impossible to time, downturn and/or recession rather than a financial crisis. While Vancouver and Toronto are clearly insane, I just don’t see how that means the whole economy is on the edge of the abyss.
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So what is Poloz supposed to do? Here is the menu of options:
- Hike rates — you’re going to need to be aggressive, Banxico-style. Remember, “real” inflation is on a 5-handle, and nobody ever defused a financial time bomb with a couple of measly 25bp hikes! CAD will strengthen materially. Sorry Prairie provinces. Sorry exporters. Sorry oil sands workers and investors. You’re to be crucified in the name of financial stability.
- Macro-prudential measures — BoC has done some here, but nothing aggressive. Perhaps rightly, Poloz is hoping governments continue to do the heavy lifting.
- Sit on your hands and hope someone else fixes it. The current strategy, and prefered solution of bureaucrats worldwide since time immemorial.
Where does that leave us trading CAD rates and FX?
The market is pricing in a very slow and small tightening cycle from the BoC: roughly 48bps in hikes in the next year starting in Q4, and 66bps in the next two years. By contrast, for the next year the market is pricing in the following moves from other relevant central banks:
Fed: +17bps
RBA: +6bps
RBNZ: +21bps
ECB: The magic 8-ball says, “Ask again later.”
But even rates modestly above the overnight came only after Poloz made some hawkish comments last week — a verbal intervention he thought was so important he did it in an interview with a radio station in Winnipeg. The Wilkins speech was on the tape too, but I’m still skeptical.
Regardless, the move higher in rates left the 1y1y spread between US and CAD rates near the middle of a two year range, while the loonie still refuses to strengthen.
A regression of the 1y1y us/cad rate spread vs. USD/CAD shows…not much. Nothing to see here, move along folks.
Lower oil prices, low interest rates and the smoldering housing price bubble are the likely culprits holding back CAD. I would tend to agree with those seeing a technical bounce/squeeze in oil over the next few weeks, which should nominally support CAD.
- I don’t see a clear trade in rates — I’d more likely be a receiver than a payer. I don’t believe Poloz will deliver on the hawkish rumblings, and foreigners will continue to buy Canadian debt. Steepeners probably make more sense here than elsewhere.
- I’d reluctantly trade from the long side in CAD, more due to valuation, positioning, relative performance given global USD weakness, and the previously mentioned bias towards a s/t bounce in oil.
If those views look inconsistent, it’s because they are. I don’t think we’re at the end of the road here — I know there are a lot of ridiculous stories of price increases and leverage, but Canada looks like it is a choppy traders’ market rather than a macro opportunity.
