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In an interview to a Quebec investment club, the Bank of Canada governor Tiff Macklim reaffirmed our central bank’s official stance that they were pretty much done with interest rate hikes, at least for now. Canadian economists breathed a collective sigh of relief, as it looked like the damage to our housing market caused by rapidly rising interest rates was coming to an end.
If new data are broadly in line with our forecast and inflation comes down as predicted, then we won’t need to raise rates further,” Macklem said in a speech to financial analysts in Quebec City. “Inflation is turning the corner. Monetary policy is working.”Bank of Canada governor says no new rate hikes needed if economy develops as expected, FinancialPost.com
Predictably, house pumpers, eager to declare the housing correction over and done with, took this early sign of progress as an excuse to ring the all-clear bell and declare a market bottom, with RBC predicting that they were seeing “early signs the correction is approaching its final stage.”
“October offered another month’s worth of data indicating that the slowdown in Canadian housing markets is coming to an end,” said Shaun Cathcart, Senior Economist at CREA.Canada Housing Market Forecast: Will Prices Drop in 2023?
I get it. In the face of economic uncertainty, it’s always tempting to ring the all-clear bell when things start to look up. But you have to remember that the people who are making these predictions are in the business of selling real estate. It’s not their job to help you make responsible decisions. It’s their job to trick as many people into buying as possible so they can keep up with their Audi payments.
And it’s easy to make that argument to the casual observer. If home price drops are caused by interest rate hikes, then a pause in interest rate hikes means that the drops should stop, right?
Well, not so fast.
Personally, I think if there is a temporary floor on housing prices, rather than a buying opportunity, we may be seeing a false bottom with further downside coming. As much as the Bank of Canada would like to keep interest rates where they are right now, there are factors that impact interest rates that they can’t control, like things that happen in other countries. Specifically, what’s happening south of the border.
Jobs Jobs Jobs
The January jobs report from the Bureau of Labour Statistics was massive. Economists were expecting some job growth, but in the range of 200,000 or less as the pace of the labour market had been gradually slowing over the second half of 2022. instead, this is what they got.
With 517,000 new jobs added in January 2023 and the unemployment rate at 3.4%, this is a blockbuster report demonstrating that the labor market is more like a bullet trainThe US economy added a whopping 517,000 jobs in January, CNN
Their unemployment rate also fell to 3.4%, which is lower than at any point under the Trump administration. In fact, it’s the lowest it’s been in over 50 years!
In short, their economy is on fire!
Which is just…super confusing.
Remember at the beginning of the year, when everyone was 100% sure that a recession was just around the corner? The debate wasn’t over whether it would happen, but when and how bad it would be. Now? The general consensus among market watchers is “What recession?” These are the numbers that show up in economic expansions, not contractions!
So all that’s great news. The US is the world’s biggest economy, and if a significant portion of your portfolio is invested in the US economy (as it should be if you followed our Investment Workshop), then you should be nicely set up to benefit from the good times coming up ahead.
But what does this have to do with our housing market? Perversely, it might actually have the opposite effect. And it all has to do with interest rates.
Like I said above, Canada’s central bank has decided to stop raising the benchmark rate. Up here, there’s a lot of worry about balancing the central bank’s primary goal of taming inflation with not toppling over our housing market. Canadians have gone into so much debt buying up residential real estate that every rate increase has the danger of throwing thousands of people out of their homes and going bankrupt.
But in the US, Americans have learned their lesson after being burnt by 2008 and have kept their borrowing in check. We, on the other hand, learned the opposite lesson.
So now, with the US economy so red-hot and their household debt levels at much more reasonable levels, there’s really no reason for the US central bank to pause their rate hikes anytime soon.
The US federal reserve chair Jerome Powell has said as much, stating that he expects that rate hikes will continue well into next year.
“We didn’t expect it to be this strong,” Powell said of the January jobs report, which showed the US economy added 517,000 jobs. “It kind of shows you why we think that this will be a process that takes a significant period of time.”Fed Chair Powell: Inflation fight will take ‘a significant period of time’, CNN
So now we have a situation where Canada’s central bank has paused their interest rate hikes out of concern for our housing market, while the US central bank is still going to be keeping its foot on the gas for the foreseeable future. And while you might be tempted to think “So what? What does their interest rate level have to do with us?”
Well, it does have an effect. And that’s because of…
The CAD/USD Exchange Rate
When interest rates start to differ between countries, their currencies get caught in the crossfire. Interest rates affect not just mortgages, but investment returns as well, and if you could make more by simply holding a currency in a savings account risk-free, you’re more likely to want to buy that currency.
This is why Canada’s central bank tries not to deviate their interest rate levels too much from the American one. If the two diverge too much, it messes up the CAD/USD exchange rate, and if that relationship gets too out of whack, it causes a whole lot of problems that impacts the rest of our economy.
Canada’s economy is designed around the CAD/USD exchange rate operating in a range of about $1.20 and $1.40 CAD to USD. We basically sell natural resources like lumber and oil because we have so much of it, and buy food because so much of our beautiful country is, you know, a frozen wasteland for half the damned year. If the Canadian dollar got too strong, our exports would become too expensive. And if our dollar got too weak, the cost of our imported goods would skyrocket. So we can’t allow the exchange rate to fall outside this $1.20-$1.40 range for too long.
Which, I fear, is exactly what’s going to happen. If we pause our interest rates while the Americans keep hiking ours, their currency is going to get more and more attractive relative to ours, and that’s going to weaken the Canadian dollar. And while that might be good news for certain sectors like border towns that rely on American tourists, it’s bad for our economy as a whole because it spikes the cost of our imports.
More Inflation, More Interest Rate Hikes
And that’s going to make our inflation worse. How could it not? We import too much of our food, and that makes our food supply chain dependent on external factors beyond our control. That’s why food prices spiked when Russia invaded Ukraine and drove up the price of oil. That increased cost of gas made the act of importing food more expensive.
A smoking-hot USD would have a similar effect.
As of the time of this writing, the CAD/USD exchange rate is $1.34. We can probably withstand that ticking up for a while, but if that number hits $1.40 our politicians are going to start panicking. Because at that point, they will be forced to choose between the needs of homeowners who are already being hurt by high mortgage rates, and the needs of people who enjoy eating food, which is *check notes* everybody.
And that’s not really a choice. They have the pick the smaller group. Which means raising interest rates even if if causes devastation in the housing market.
Now, don’t get me wrong. I’m not saying this will definitely happen. If the next couple jobs reports out of the US suck, then none of this will happen. But I do want to caution people that just because the Bank of Canada is telegraphing that they’re done with interest rate hikes doesn’t mean that the housing market has found a bottom. Their hand may be forced by factors outside their control.
What do you think? Do you think the Canadian housing market will find a bottom this year? Or is there more pain ahead? Let’s hear what you think in the comments below!
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