Rising rates top economic menace
Whenever asked what is the greatest risk to t he global economy, I often reply that the answer to this question can be found right in our own backyards.
Albertans are now facing one of the longest oil downturns since the 1980s and yet its housing market has hung in remarkably well. In fact, despite oil prices being halved, average housing prices are still up 17 per cent in Calgary and 13 per cent in Edmonton over the past five years according to recent Teranet data.
Contrast this to the first five years in the 1980s, when Calgary home values lost more than a third of their value. The big difference between now and then is that mortgage rates were setting record highs in the double digits while today they’re setting record lows.
We belie ve t hat if it weren’t for the meltdown in oil prices Albertans would be fully participating in the country’s rocketing real estate market with April being the busiest month in Canadian history for home sale activity. To add some further perspective, over the past five years housing prices in Vancouver and Toronto are now up 39 per cent and 44 per cent, respectively.
Central banks are keenly aware of the strong relation- ship between asset inflation and interest rates. Housing now makes up the largest component of people’s net worth and t here fore remains a key factor in building consumer confidence and i ncreasing spending levels.
The Bank of Canada, for example, gave the real estate market a huge boost last year via its two rate cuts, sending a clear message to both Canadians and foreigners.
Things are really getting interesting globally though with central banks like the ECB sending interest rates into negative territory and some countries like Denmark now offering negative mortgage rates. This is truly remarkable and something most pundits once thought impossible.
In this environment, we find i t rather perplexing that the U. S. Federal Reserve has been rather hawkish lately setting a tone for rate hikes later this year. Perhaps this is because Fed representatives are thinking about their economy in isolation of the current global macro- economic outlook which remains challenged at the moment.
We also t hi nk many economists and market participants are underestimating the rippling effect rate hikes and a higher U. S. dollar will have on both the U. S. and global economy. That said, the positive in all of this is that this could result in a transfer of wealth from the U. S. into export driven economies like Canada, especially should the currencies react accordingly. This shouldn’t be a problem as long as the transfer isn’t too large, thereby hurting the U. S. corporations that generate a significant amount of revenue from abroad.
For us Canadians, this is a good news/bad news scen- ario with a lower loonie continuing to provide strong stimulus to all of the foreign buyers of our real estate in addition to Eastern Canada benefiting from greater export activity. On the flip side, a higher dollar could derail the current recovery in oil prices, thereby meaning more pain ahead for Albertans.
Finally, while the baby boomer generation is beholden to low interest rates and bond yields at l east their home prices for the most part have appreciated handsomely.
That said, many are also being forced to explore riskier investments in order to generate a high single- digit return.
Record l ow mortgage rates should also help offset the increase in housing costs for new millennial home buyers — it just means leveraging up which is exactly what central bankers want to happen.