Juggling Dynamite

Four easing cycles have seen the Bank of Canada deliver larger than 25 basis point rate cuts at a time: 2001, after the US dot-com bubble and Sept. 11 attacks; during the global financial crisis; in the COVID economic shock of 2020 (see chart on the left); and now, in 2024. See Bank of Canada’s Deeper Cut Aims to Reignite a Sluggish Housing Market.

With some 58% of Canada’s GDP growth driven by consumer spending, it matters that Canadian retail sales ex-autos (a coincident economic indicator) have fallen per capita since 2021 (yellow line below since 2018, courtesy of RBC economics). See RBC: Canadians are tapped out.

At the same time, Canada’s unemployment rate (a lagging economic indicator) was up 170 bps to 6.5% in September from a cycle low of 4.8% in June 2022  (blue line below since 2021), which is above pre-pandemic levels. Job openings nationally are 25% below year-ago levels (yellow line since October 2021). Deteriorating employment makes it harder for households to make ends meet. See RBC: The job market is a bigger threat to Canada’s economy than mortgage renewals.

There’s never been a time when the Canadian unemployment rate increased more than 100 bps from the cycle low when Canada was not in a recession. The consensus hopes that this time will be different.

Canada’s population is aging quickly. As of the latest StatsCan data, seven million Canadians aged 65 and older accounted for more than one-fifth of the total population (21.8%), up from 16.9% in 2016, and compared with six million children (16.3% of the total Canadian population in 2021).

The population aged 85 and older is one of the fastest-growing age groups, with a 12% increase since 2016. Over 861,000 people aged 85 and older were counted in the 2021 Census, more than twice the number observed in 2001. Over the next 25 years (by 2046), the age 85+ cohort will triple (to nearly 2.5 million people).

As weak as Canada’s economy has been, over the past couple of years, immigration has been the main driver. Today, the Federal government announced a reduction in immigration targets, implying that Canadian population growth will be zero over the next two years. This should further reduce Canada’s economic growth. On the upside, it should be disinflationary by alleviating some demand pressure on housing just as a surge in new supply is coming to market in key areas. Shelter costs make up 28% of Canada’s Consumer Price Index. See more, BMO: Canada’s Immigration Rethink:

“For housing, this move will dampen price pressures
and rents, all else equal (e.g., rate cuts and mortgage
rules). That said, the sudden shift in Temporary Resident inflows should
clearly soften the rental market just as a torrent of supply is coming online in some regions (e.g., Toronto condos).Growth in average asking rent across Canada has slowed to just 2% y/y according to Rentals.ca, with outright declines seen in some markets. We’ve long argued that Canada has a housing demand problem. This policy change will be felt quickly and will make other supply-side measures look almost like rounding errors.

On September 18, the US Fed cut its overnight target rate by 50 basis points (bps), and risk markets went wild. Stock and corporate debt prices have risen to more all-time highs, and real estate bulls rejoice that lower interest rates will reignite loan demand and save highly leveraged property markets.

The trouble is that central banks don’t control fixed-term loan rates. The Treasury market sets those, and the Treasury market hasn’t been cooperating.

From 3.93% in mid-October, the US 30-year Treasury yield rose 54 bps to 4.47% yesterday, pushing 30-year US mortgage rates to 6.8% from 6.1% in September (and 2.7% at the low in 2021). Not surprisingly, US mortgage applications fell 17% in the second week of October—the sharpest weekly contraction since 2015 (outside of early 2020 during the pandemic). Sale prices registered month-over-month declines in ten US states (Reventure data).

In Canada, the Bank of Canada has lowered its overnight rate from 5% to 4.25% and is expected to deliver another 50 bp rate cut tomorrow (some are calling for 75bps).

So far, Canada’s 5-year Treasury bond yield has risen from 2.69% on September 16 to 3.01%, and Canada’s fixed-term mortgage rates have moved back above 4% (from less than 2% during the early pandemic).

Most Canadian realty markets are stagnant. Some are downright dead: new condo sales in the Greater Toronto and Hamilton area (all the rage during the easy-money mania) hit a near 3o-year low in the third quarter with volumes -63% year-0ver-year.

The median Canadian home sale price in September was $669,630, down 20% from $835K at the manic peak in February 2022. Nationally, new listings are up 16.8% year-over-year. See CREA lowers housing market forecast for 2024 amid a ‘holding pattern’ for home sales.

Despite central bank rate cuts, real interest rates (nominal minus inflation) remain near the highest since 2008 (US 10-year real rates below since 1980). High real yields are great for savers but not for the indebted masses, and the world economy has never been more indebted than today.

As I’ve noted many times, it’s been typical for risky assets to celebrate when the US Fed starts easing and for Treasury prices to initially drop (yields to jump) as they do.

The 56bp increase in the US 10-year Treasury yield since September 18 is, so far, the third largest following the first Fed cut since 1995 (chart below, courtesy of Bespoke Investments). In every case, the initial yield back-up was short-lived before spreading economic strife led to a sell-off in risky assets, a flight to safety, and a rebound in Treasury prices (lower yields) as central banks continued slashing overnight rates throughout. The trouble with central bank rate cuts is that they come too little, too late. It is too late to save those who took on too much debt and overpaid for assets during the easy money mania, and it is too late to stop recessions and asset bubbles from popping in their usual course.

Aged populations are ballooning government deficits in most countries.

The Bloc Québécois has threatened to force a snap election if Canada’s federal government doesn’t increase Old Age Security payments for people between the ages of 65 and 74 by 10 per cent. Andrew Chang breaks down the dilemma before the Liberals and why economists say the move could indebt an entire generation. Here is a direct video link.