Juggling Dynamite

Canadian 5-year fixed mortgage rates have moved above 4% and (as shown below) US 30-year mortgage rates above 5%, up more than 1% in just the last month (similar leap in Europe). This rapid 25% increase in interest costs, coming amid highly indebted households and corporations, is the most significant financial shock since 2007.

Bond markets have now priced in the most aggressive central bank hiking cycle in the last 45 years, as shown below courtesy of Bloomberg.

In the process, the Bloomberg Global Aggregate Bond Index (shown below) has fallen under the key 100 ‘par value’ level for the first time since 2008. This level turned out to be a lucrative buying opportunity for bonds in 2008.  As the economy slows, and central banks end up walking back their tightening plans, it’s likely we will look back on this latest rate shock as another valuable opportunity to add the highest quality bonds at higher yields than we may see again for a few years.

Cycle analyst Eric Basamajian discussed the rate shock ramifications in the interview below and offers an insightful big picture on the housing market, economic cycle and more. Host Hartman asks him about many of the mainstream bullish talking points.

Eric Basmajian, economic analyst and founder of EPB Macro Research. Jason Hartman and Eric discuss the rapid decline in real personal income and standard of living, how the rate shock will filter through to the housing market and much more. Eric also talks about the single most important variable to understand where the next 10 years of the real estate market are going and the four corners of an economy: income, consumption, employment and production.  Here is a direct video link.

As household savings and cash flow have been increasingly needed for basic necessities like food, fuel and housing, the economically-sensitive household spending intentions on durable goods have tumbled to the lowest level since the double-dip recession of 1980-81.  One of the most impactful sectors here, auto sales fell to a 13.33 million annualized rate in March, down 30% from their cycle peak last April (shown below).

At the same time, importers of durable goods, stressed by supply chain disruptions during the pandemic, over-ordered goods in anticipation of a continuation in elevated demand.  This has helped to push inventories (logistics managers index below) to a record high above 80 as of February data. Inventory overbuilds typically lead to deflationary liquidation cycles and economic weakness as prices get marked down to clear.

The transportation sector also ramped up its fleets for hire since 2020.  In the chart below, forty-two-year transport vetran Craig Fuller shows that trucks in the market recently surpassed freight volume as they have at other cycle tops. (blue= trucks in the market; green = truckload volume).

Craig doesn’t think this time is different, as he explained on Twitter last week:

I’ve heard in every cycle all the reasons that “this time is different.” It never is. The trucking market always over builds and then crashes. Always. Buckle up – its going to be a tough ride from here. End.

— Craig Fuller 🛩🚛🇺🇦 (@FreightAlley) March 29, 2022

As government bond prices have declined on expectations of aggressive rate hikes from central banks, fixed mortgage interest rates (priced off bond yields), have leapt. After rising sharply during the pandemic, high home prices have now combined with higher interest rates to drive a 30.5% year-over-year increase in US mortgage payments to the end of March (charted below in red, courtesy of The Daily Shot).

This is a massive rate of change and a marked departure from the year-over-year trends in 2020 (when interest rates fell) and 2021 (when they flatlined).

In Canada, affordability is much worse (graphed below through the first half of 2021). The median home price nationally has risen from $580,000 in 2019 to $880,000 in 2022, and five-year fixed mortgage rates from 1.4% in 2021 to over 4% today (as I discussed here in Mortgage math matters). The median Canadian monthly mortgage payment for the median home has doubled from about $1855 in 2020 to more than $3660, while real household incomes have flatlined.

When home prices overshot income gains by much lesser amounts in the late 1970s and 1980s, the disconnect was short-lived before median home prices fell more than 30% nationally.

The median US home price went from 4.2x the median household income in 2019 to 5.6x by 2021. As interest rates have jumped, home affordability (shown below) is now fathoming the 2007 cycle lows from which home prices began a 40% multi-year decline nationally.

Not surprisingly, demand for rental apartments hit a record high in the first quarter of 2o22. Median national rents have increased 17% year-over-year (the US below). Still, higher rents notwithstanding, as in 2005-2008, it remains cheaper to rent today than to own a single-family home (shown below since 2000).   Historically, this measure has been an insightful indicator of the relative risk and reward in home prices. Eventually, the math does matter, and word on the street is that Canadian home sale prices dipped in March as the number of transactions fell.

Even perenially myopic central banks see magnified downside risk in housing and the highly levered economy. This week, the Dallas Fed issued a report entitled Real-Time market monitoring finds of brewing housing bubble. Here’s a taste:

Our evidence points to abnormal U.S. housing market behavior for the first time since the boom of the early 2000s. Reasons for concern are clear in certain economic indicators—the price-to-rent ratio, in particular, and the price-to-income ratio—which show signs that 2021 house prices appear increasingly out of step with fundamentals.

While historically low interest rates are a factor, they do not fully explain housing market developments. Other drivers have played a role, including pandemic-related U.S. fiscal stimulus programs and COVID-19-related supply-chain disruptions and associated policy responses. The resulting fundamental-driven higher house prices may have fueled a fear-of-missing-out wave of exuberance involving new investors and more aggressive speculation among existing investors.