Juggling Dynamite

Debt payments consume an impossible amount of household income, and the problem is global.

Across ten large Canadian cities, mortgage payments alone are eating up about 59% of household earnings, based on mortgages amortized over 25 years. This is with 70% of Canadian mortgages still paying fixed payments based on rates less than 3%. With current mortgage rates around 6 percent, interest costs will double and more as terms come due.

Twenty-five percent of the mortgage book at Canadian banks is negatively amortizing today (i.e., loan balances increasing monthly) with amortization periods over 25 years. Regulators have instructed banks to bring these loans back to conventional 25-year amortization, stat.

In Toronto and Vancouver, mortgage payments on the median home consume the vast majority of household income, according to economists at National Bank of Canada. See Home prices in Canada are so stretched that even owners want them to fall.

Meanwhile, even with a whopping bear market rally in the S&P 500 from October to August, it has been 616 days (1.7 years) since the index made a new cycle high; this length of price stagnation has only happened seven times in the past seven decades, and only within ongoing bear markets.

Aggregate hours worked have been stagnant for six months and US non-farm payrolls have been revised lower for seven consecutive months–an extended pattern only seen during past recessions.

“We really are starting to see multiplying signs of stress in the consumer sector.” Danielle DiMartino Booth, chief executive officer and chief strategist at QI Research, discusses the US economy, oil prices and her outlook for the labor market. She speaks on Bloomberg Television. Here is a direct video link.

For those who like detail, Francois Trahan of Trahan Research offers a cogent macro assessment in his latest video update (1-hour run time): “Wall Street’s Soft-landing Delusion and What Really Comes Next!”

You can watch it at this direct video link.

The San Fransisco Federal Reserve published its latest economic letter last week, entitled Does Monetary Policy Have Long-Run Effects? The conclusions are clear: loose monetary policy does not raise long-run economic potential while the eventual tightening of policy reduces economic output for a decade and beyond. We have entered the payback decade:

Analyzing cross-country data for a set of large national economies since 1900 suggests that tight monetary policy can reduce potential output even after a decade. By contrast, loose monetary policy does not appear to raise long-run potential. Such effects may be important for assessing the preferred stance of monetary policy.

… in response to a 1% increase in interest rates, output would be about 5% lower after 12 years than it would otherwise be. To provide some context for these numbers, consider some data for the United States. A 5% decline in the output trend caused by the monetary intervention relative to the pre-intervention trend would reduce an individual’s income by $3,000 in today’s dollars on average.

…If raising interest rates can have such costs in terms of the longer-run capacity of the economy, what about lowering rates: can a central bank boost the economy’s long-run potential with more accommodative monetary policy through lower interest rates?

Figure 2 (below) shows that this is not the case. When we separate our interest rate experiments into those that resulted in rate hikes versus those that resulted in lower interest rates, we see that there is no free lunch. That is, a central bank might not be able to undo the long-run effects on the economy’s potential by running the economy hot. The blue line shows that lower interest rates have mostly temporary effects that vanish after a few years, as traditional theories predict. However, the red line reinforces the results from Figure 1 that show an increase in interest rates casts a long shadow on the economy.