Statistics released today by the Canadian Real Estate Association (CREA) show home sales were up 1.3% on a month-over-month basis in October. Still, monthly activity remained a whopping 36% below the October pace in 2021. The housing correction continues in response to the Bank of Canada’s massive rate hikes, but the speed of the correction is slowing.

“October provided another month’s worth of data suggesting the slow down in Canadian housing markets is winding up,” said Shaun Cathcart, CREA’s Senior Economist. “Sales actually popped up from September to October, and the decline in prices on a month-to-month basis got smaller for the fourth month in a row.”

You can see from the chart below just how slight the uptick in October home sales was, but at this stage, it shows that a housing crash is not occurring.

With sales up by a little less than new listings in October, the sales-to-new listings ratio fell to 51.6% compared to 52% in September. The long-term average for this measure is 55.1%.

There were 3.8 months of inventory on a national basis at the end of October 2022, up slightly from 3.7 months at the end of September. While the number of months of inventory is still well below the long-term average of about five months, it is also up quite a bit from the all-time low of 1.7 months set at the beginning of 2022.

The Aggregate Composite MLS® Home Price Index (HPI) edged down 1.2% month-over-month in October 2022, the smallest decline since June.

The national average transactions price fell 9.9% y/y  in October, while the MLS HPI dipped 0.8% y/y with downward momentum continuing on a month-to-month basis. The HPI is now down eight months or an even 10% from the February high. With mortgage rates across the spectrum pushing above 5% as the Bank of Canada tightens further, this downward price discovery will probably persist well into next year.

In Ontario, for example, the sales-to-new listings ratio has weakened to just above the 40% level. In some markets outside the core of the GTA, benchmark prices are easily down 15%-to-20% from their early-year highs already. It’s a similar situation in B.C. where, while Vancouver is correcting, markets 1-to-2 hours outside the core are doing so even faster—none of this is a surprise given how sharply these exurban markets ballooned during the pandemic. Meantime, Atlantic Canada is holding up relatively well thanks to an ongoing population influx, while Alberta (and the Prairies more broadly) still look pretty solid.

The Bank of Canada slowed its tightening pace to 50 bps when it met in late October. Since then, the US inflation has slowed a bit, causing longer-term bond yields to fall meaningfully. Tomorrow, Canada will release its latest inflation report. All eyes will focus on core inflation (which excludes food and energy prices) in the hopes that evidence will also validate a slowdown in those measures.

The Bank of Canada’s policy announcement date is not until December 7th, when another rate hike is widely expected. Tomorrow’s inflation report will give us a better sense of whether a 25-bps hike might be possible.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Excluding food and energy, prices rose 5.4% year-over-year (y/y) in September, following a gain of 5.3% in August. Prices for durable goods, such as furniture and passenger vehicles, grew faster in September compared with August. In September, the Mortgage Interest Cost Index continued to put upward pressure on the all-items CPI Canadians renewed or initiated mortgages at higher interest rates.

Monthly, the CPI rose 0.1% in September. On a seasonally adjusted monthly basis, the CPI was up 0.4%.
Average hourly wages rose 5.2% on a year-over-year basis in September, meaning that, on average, prices rose faster than wages. The gap in September was larger compared with August.

In September, prices for food purchased from stores (+11.4%) grew faster year-over-year since August 1981 (+11.9%). Prices for food purchased from stores have increased faster than the all-items CPI for ten consecutive months since December 2021.

Contributing to price increases for food and beverages were unfavourable weather, higher prices for essential inputs such as fertilizer and natural gas, and geopolitical instability stemming from Russia’s invasion of Ukraine.

Food price growth remained broad-based in September. On a year-over-year basis, Canadians paid more for meat (+7.6%), dairy products (+9.7%), bakery products (+14.8%), and fresh vegetables (+11.8%), among other food items.

Price pressures might have peaked, but today’s data release will not be welcome news for the Bank of Canada. There is no evidence that core inflation is moderating despite the housing and consumer spending slowdown. The average of the Bank’s favourite measure of core inflation remains stuck at 5.3%. Combined with the Governor’s recent harsh rhetoric, the high probability that the Fed will hike rates 75 bps at the next Federal Open Market Committee Meeting and the weak Canadian dollar, there is no doubt the Bank will increase their overnight policy target to at least 3.75%, and could well go the full 75 bps to 4.0% next week. I would bet that they will not quit there, with further hikes to come in December and next year by central banks worldwide.

The Government of Canada yield curve is now steeply inverted, reflecting the widely held expectation that the economy is slowing. The prime rate will increase sharply next week, increasing variable mortgage rates again. Fixed mortgage rates will rise as well, but not by as much, continuing a pattern we’ve seen since March when the Bank of Canada began the current tightening cycle. We are unlikely to see a pivot to lower rates in the next year as inflation pressures remain very sticky.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

You can see in the chart below that in late 1979, the Volcker Fed hiked the overnight policy rate to levels well above the inflation rate and kept real interest rates (nominal rate minus inflation rate) positive for an extended period.

The current Fed Chair, Jay Powell, has expressed deep admiration for Paul Volcker, calling him “the greatest economic public servant of the era.” Last month, Powell alluded to his predecessor’s record of persistence, saying that policymakers “will keep at it until the job is done” — invoking Volcker’s memoir, “Keeping at It.”

The Bank of Canada was no slouch on the inflation front as well. As the chart shows, the Bank hiked interest rates in lockstep with the Fed in the Volcker years and even more in the early 1990s when Ottawa was fighting Canadian budgetary red ink to the ground.

This time around, Tiff Macklem has been ahead of the Fed in hiking interest rates and, in a speech on Thursday, said that the economy is still “clearly” in excess demand, with businesses facing an extremely tight labour market, wage gains broadening and underlying inflation pressures showing no signs of letting up. Macklem said that the sources of inflation, which started with goods prices, are broadening to the service sector. “. Labour markets remain very tight. Job vacancies have eased a little in recent months but remain exceptionally high. Our business surveys report widespread labour shortages. And wage growth has risen and continues to broaden.”

“With demand running ahead of supply, competition is posing less of a restraint on price increases, and businesses are passing through higher input costs more quickly. As a result, higher energy and material costs are showing up in the prices of a growing list of goods and services. So even if there is some relief at the gas pumps, price pressures remain high and continue to broaden. In August, the prices of more than three-quarters of the goods and services that make up the CPI were rising faster than 3%.”

Macklem continued, “As we look for a more fundamental turning point in inflation, measures of core inflation are becoming increasingly relevant…after taking out volatile components in the CPI that don’t reflect generalized changes in prices, inflation is running about 5%. That’s too high. We can also see that our core measures have yet to decline meaningfully even though total CPI inflation has come down in the last couple of months. Going forward, we will be watching our measures of core inflation closely for clear evidence of a turning point in underlying inflation.” In conclusion, the governor said, “there is more to be done….We know we are still a long way from the 2% target. We know it will take some time to get there. We also know there could be setbacks along the way, and we can’t afford to let high inflation become entrenched.”

There are many views on how far the central banks will have to hike rates from here, but the critical issue is to reach a point where rates are meaningfully restrictive. A rule of thumb is that the overnight policy rate must rise to exceed the inflation rate. Fed Chairman Powell has said that he believes that real interest rates should be positive across the yield curve. Today, long and short US rates are still the lowest compared to inflation since the Burns era in the mid-1970s. (see chart below). Traders are betting that the US overnight rate will rise another 125 basis points (bps) by yearend and continue to rise next year to a median estimate of 4.6%.

Short-term money markets are betting the Bank of Canada will stop its hiking cycle at about 4%, versus a Fed benchmark rate peaking at about 4.6% and remaining below US short-term rates for at least another three years.

This is especially unreasonable given the fall in the Canadian dollar, which is now trading at US$0.728 compared to US$0.814 one year ago. This depreciation reflects the inordinate strength of the US dollar–the global safe-haven currency in a time of enormous uncertainty and volatility. The Canadian dollar has fared far better than other G-7 countries over this period. But the decline in our currency will raise the prices of the many US products and services we import, adding to inflation.

Inverted Yield Curves

In Canada and the US, 2-year yields have risen sharply to levels well above 5-year yields. As of October 6, the 2-year Government of Canada bond yield is at 4.0% compared to the 5-year yield at 3.49% and the 10-year yield at 3.31%. This implies the markets expect a slowdown in economic activity, but that does not mean that the overnight policy rate will fall in 2023 as Bay Street expects, especially if core inflation remains well above 2%. The Canadian prime rate is currently 5.45%, well above the 5-year yield of 3.49%. When the Bank of Canada Governing Council meets again on October 26, it will likely raise the policy rate by at least 50 bps to 3.75%, taking the prime rate up to 5.95% or higher—clearly improving the relative attractiveness of fixed-rate mortgage loans.

For most of my readers, inflation is a brand-new experience, and so are rising interest rates. Inflation in Canada was at 2.2% when the pandemic began, and the 5-year bond yield was a mere 1.3%. Quickly the central bank cut the overnight rate from 1.75% to 0.25%, the prime rate fell from 3.95% to 2.45%, and the 5-year bond yield fell to a low of about 0.32%. Housing demand exploded and continued strong until it peaked in February 2022 when the Bank of Canada began to hike interest rates.

Interest rates will not fall to pre-pandemic levels next year or even the year after. And we will likely never see interest rates at pandemic levels again, at least I hope not, because it would take another global economic shutdown. Hence, mortgage-borrower psychology will change. Many more homeowners will choose to lock in fixed interest rates, and by the time this is over, a new generation will realize that interest rates don’t just fall but sometimes rise to levels higher than expected and stay there longer than expected—a painful lesson to learn.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

We know that residential construction projects have been postponed or cancelled owing to the rise in borrowing costs and the slowdown in home sales. There were also fewer workers in construction (-28,000; -1.8%) in August, with the decrease spread across several provinces, led by Alberta (-11,000; -4.6%) and Ontario (-10,000; -1.6%).Total employment fell in British Columbia, Manitoba, and Nova Scotia, while it increased in Quebec. There was little change in the other provinces.

Total hours worked were unchanged in August, following a decline in July (-0.5%). On a year-over-year basis, total hours worked were up 3.7%.

Hybrid Work Continues

Working from home continues to be an important feature of work for many Canadians, although the specific nature of the arrangement continues to shift. As of August, 16.8% of employed Canadians reported that they usually work exclusively from home, down from 18.0% in July and down 7.5 percentage points since the beginning of 2022. The proportion of workers with a hybrid work arrangement—those who usually work both at home and at locations other than home—increased by 0.7 percentage points to 8.6% in August.

The unemployment rate was 5.4% in August, up 0.5 percentage points from the record low of 4.9% observed in June and July. This was the first increase not coinciding with a tightening of public health restrictions since May 2020, when the unemployment rate reached its pandemic peak.

The unemployment rate increased for four of the six main demographic groups in August, including young men aged 15 to 24 (+1.2 percentage points, to 11.0%); women aged 55 and older (+0.7 percentage points, to 5.2%); core-aged men (+0.6 percentage points, to 4.6%); and core-aged women (+0.4 percentage points, to 4.5%). It was little changed among young women and older men.

The adjusted unemployment rate—which includes people who wanted a job but did not look for one—rose 0.5 percentage points to 7.3% in August. This increase was largely due to the rise in the number of unemployed rather than an increase in those who were outside the labour force but wanted work.

The hope is that the rising number of unemployed Canadians will help to fill the record job vacancies.

Particularly troubling for the Bank of Canada is the further acceleration in average hourly wages, which rose 5.4% on a year-over-year basis in August, compared with 5.2% in June and July (not seasonally adjusted).

Bottom Line

The Bank of Canada will welcome the cooling labour market, which will ultimately take the pressure off wage inflation. I don’t expect today’s weaker jobs report to change the Bank’s view that interest rates need to rise further in the coming months to return inflation to its 2% target level.

In Other News Today, OSFI Refuses To Succumb to Pressure To Loosen B-20

OSFI first created its Residential Mortgage Underwriting Practices and Procedures Guideline (B-20) in 2012. The guideline set expectations for residential mortgage underwriting for federally regulated lenders.

“The uncertainty and anxiety caused by a rising interest rate environment have, understandably, caused some Canadians to advocate for a loosening of the underwriting standards in Guideline B-20,” Routledge said.

“Let me reassure those of you who oppose a loosening of underwriting standards that OSFI will not do that.”

In June, Canada’s banking regulator announced that it tightened underwriting standards on combined loan plans such as reverse mortgages, mortgages with shared equity features and combined loan plans.

Routledge reiterated that OSFI is “constantly evaluating the MQR (Minimum Qualifying Rate) to measure its efficacy in sustaining sound residential mortgage underwriting.”
“Because Guideline B-20 touches home ownership, it gets an extraordinary amount of public attention – at least relative to all our other regulatory guidelines,” Routledge said.

“We accept this reality – housing is crucial to all Canadians, and Guideline B-20, whether we at OSFI like it or not, matters to Canadians. And so, our job is to address concerns with B-20 transparently and forthrightly”.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

There are still labour shortages in businesses that need customer-facing employees–think restaurants, hotels, travel, retail, household services, as well as in construction and the trades. But we are also now hearing of layoffs and cutbacks in businesses that boomed during the lockdowns. Many of those over-expanded and are currently cutting back. A great Canadian example is Shopify, but the same can be said of major retailers like Walmart and Target, which now find themselves overstocked.

The housing markets in Canada are slowing sharply, especially in the highest-cost regions around the Greater Vancouver and Toronto areas.

Central banks worldwide took interest rates down to near-zero levels in the early days of the pandemic, triggering a massive boom in housing. Canada’s boom was second to none, reflecting the long-standing housing shortage. Since 2015, home construction for rent and purchase in Canada has paled compared to the rising demand generated by surging immigration targets. First-time buyers’ FOMO, combined with record-low mortgage rates, especially on variable rate loans, triggered a buying frenzy. Millennial parents helped by tapping their homeowner equity to make those down payments possible. Some of those parents could be left with the legacy of home equity loans whose monthly payments have sky-rocketed with the prime rate. Cabin fever during lockdown generated a host of other buyers who just wanted more space and were willing to move to the exurbs and beyond to afford it. Investors, long tantalized by the surge in condo prices and the growing demand for rental properties, piled on.

Central banks kept interest rates too low for too long. They should have started to raise them when inflation percolated. They thought inflation was transitory, and we all thought vaccines were the magic bullet to end the Covid pandemic. The Russian invasion of Ukraine created the perfect storm, exacerbated by China’s zero Covid policy. Supply chains crumbled further, and commodity prices surged.

Now that oil prices below $90 a barrel have returned to pre-war levels, and gasoline prices have fallen since early June, inflation might have peaked. But central banks must continue tightening to return policy interest rates to normal levels. This means an overnight rate in Canada of roughly 3.5% and nearly 5% in the US. That’s still a far cry from today’s level of 2.5%. And the central banks will not and cannot return rates to last year’s lows. Not soon, and possibly not ever. Unless you believe an equivalent global shutdown will be required sometime in the foreseeable future.

The economy lost 30,600 jobs last month, adding to a loss of 43,200 jobs in June. Canada’s job market is losing momentum as the broader economy is cooling. The job loss also reflects labour shortages and insufficiently trained new workers. Just look at the chaos at Pearson Airport. Labour market conditions are still very tight, and wage rates are rising, up 5.2% y/y last month.

In other relevant news today, Bloomberg reports that “US employers added more than double the number of jobs forecast, illustrating rock-solid labour demand that tempers recession worries and suggests the Federal Reserve will press on with steep interest-rate hikes to thwart inflation.” So much for a Fed pivot. The idea that the bond market rallied on the premature news of a US recession made no sense at this point in the cycle.

Similarly, the Bank of Canada is still likely to hike the policy rate by 75 basis points when they meet again on September 7. That would take the prime rate up to 5.45%. Currently, the 5-year government of Canada bond yield is 2.87%, well below its peak of 3.6% in mid-June. Consequently, we may see variable mortgage rates rise above fixed rates before year-end.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres