Canadian real estate got a shout out in a discussion between two prominent figures on Bay Street. Benjamin Reitzes, BMO’s managing director of macro strategy, and host of Views From The North podcast, mentioned double-digit drops for home prices in the not-so-distant future. Along with guest Joel Prussky, the two discussed how the past 15 years have been unusual for rates. More recent moves and higher inflation might be scary, but it marks the return to a healthier market. Here are the most important takeaways from the chat between the two.
“Shocked” If Canadian Real Estate Prices Don’t Fall Double-Digits
The interview largely focused on fixed income and touched on Canadian debt levels. Canadians are more indebted than Americans and thus are more sensitive to rate hikes. The more sensitive households are to rate hikes, the more their consumption slows as a result. Rates haven’t even hit January 2020 levels but we can already see the impact on real estate.
Home prices and sales are cooling following rising rates, abruptly ending an unsustainable run. “Things have come off [highs] very quickly and will probably continue to do so,” said Reitzes.
Adding, “I mean, I’ll be shocked if home prices don’t fall double digits in relatively short order. Getting them back to trend is something like 20 plus percent decline in home prices. Every pocket of the country’s a little bit different, but it’s probably going to be a challenging period.”
Rising Rates Aren’t Unusual, The Past 15 Years of Policy Have Been
Most people think of the decade ending in 2020 as a new normal, but it was far from it. After the Global Financial Crisis, central banks provided liquidity to help a recovery. Being a liquidity provider of last resort, that made sense — for a while.
The issue is it was done for too long, creating a moral hazard for the public. There’s no shortage of articles in the media claiming rates at these levels are punitive. However, interest rates are lower than January 2020. Canada and the US also happen to have tight labor markets and soaring inflation.
The low rate crowd is clamoring for the central bank to ditch its last resort position. Instead, they want the central bank to mitigate any excessive risk they’ve taken.
Prussky, managing director at BMO Capital Markets, told Reitzes this might be over. “I like to think of the last 15 years as an abnormal period in history of interest rates of the world, not what is going to be the future,” he said.
He adds, “I think when we are above 3% we were resetting to a more reasonable level of rates, but I think you have to see where inflation settles into, and where overnight settles into before you make that call.”
Markets Have Forgotten The Price of Risk
Traditionally, interest costs rise to slow demand when inflation or risks are rising. Rates are cut to stimulate demand when inflation or risks are falling. It’s typical business cycle stuff, but it’s become less accepted by central bankers. The business cycle is being suppressed more frequently with “unconventional” monetary policy tools. Consequently, it’s created a moral hazard where few understand the cost of risk.
Prussky argues, “… we’ve had since ’08 all this QT and balance sheet explosion, we don’t really know the true price of money. All I read every day is how Treasury liquidity is terrible. I mean, we’ve experienced that in Canada for years, but of course it’s terrible. The Fed’s been buying too many bonds for too long and we forgot how to find the clearing price for risk. We don’t know it”.
In other words, getting back to where the markets were in the 2010s won’t get us back to normal. That was largely a low rate experiment that helped to create moral hazard. As rates and inflation resume to more traditional numbers, markets may return to seeing a healthy level of risk.