Controlled demolition? Is it Good or Bad?

The Bank of Canada (BoC) has been telling us that it needs to increase rates. The frequency and amplification of their message has been steadily rising. As their message becomes louder, the market begins to make its own noise.

We can try to predict what further rate increases will bring to the market, but we don’t have to. The BoC has created an area on their website that does the job for us. It is called The Financial System Hub. In this research-heavy area, they provide staff notes and run complicated models to see how our economy will fare under different economic scenarios. The scenario I found the most interesting shows how the economy would manage a 20% drop in real estate prices. To be fair the BoC is clear that they assign a low probability to this scenario, but the mere existence of this report is interesting.

Are we heading into a controlled demolition of our economy?Like this article? Click here to receive our newsletter every time!
By issuing the report, we can tell that The Bank of Canada is worried about the consumer response to increasing debt servicing costs. Canadians are carrying a great deal of debt right now, even if it has abated from the recent peak. Clearly, the relationship between increasing rates and disposable income is on the BoC’s radar. When the Central Bank prices out the impact of a 20% decrease in housing prices, regardless of the probability they assign, we should probably be cautious.

We have been in a period of economic expansion since 2009. The growth of asset prices in the past 10 years has been fuelled by low cost debt and liquidity. In Canada, the United States and around the world, central bankers are now trying to reign in debt levels to slowly curb the rapid asset price growth we have seen. If we let asset prices continue to grow we only exacerbate the coming recessionary period. It is for this reason the current round of interest rate hikes are likely what the market needs. Are you ready for an analogy?Like this article? Click here to receive our newsletter every time!The Boat

It strikes me that managing the Canadian economy must be like setting the dinner table on a boat. Make sure everything is where it needs to be to ensure that everyone can eat enough, without over-eating. Unfortunately the boat is subject to massive tsunamis that can pick it up and turn it on its side at a moment’s notice. If Canada operated in a vacuum, we wouldn’t have to worry about how a trade war between the US and China might affect us. Nor would we be concerned if the US sunk into a deep recession as their interest rates started to increase. Since we are not in a vacuum, we are not really the masters of our own economic destiny.

Demolition cannect talk

Canadian consumers have seen their house prices increase dramatically over the past 15 years. We have not only come to rely on the equity in our homes to help us make investments, but also to supplement our disposable income. This reliance is what the BoC is trying to stop.Like this article? Click here to receive our newsletter every time!The Trip

There are two tenets that you should consider as The BoC starts on its path to increasing rates

  1. Save for the Future: Rising interest rates provide the BoC with ammunition in the event that we should head into a recession. Simply put, increasing rates now gives us more runway to reduce rates when the economy goes into a recessionary period. Think about it, if your borrowing rates are at 0% heading into a recession, you don’t have many tools left to try to stimulate the economy.
  2. Goldilocks: Rising rates can easily incite the recession we are so carefully modeling for. If we increase rates too fast, we risk bringing the recession on more quickly, while Canadians still have too much debt. This would result in a recession that has more pronounced negative effects. However, if we wait too long to increase rates we could create a bigger problem as borrowers become too comfortable with low borrowing costs and debt levels balloon.

The Takeaway

What we should take away is that the BoC is trying to slow our economy down. Whether this controlled slowdown will happen in 6 months, or in 24 months, depends on both the speed which rates rise and which consumers step back from debt. Make no mistake, this is a controlled demolition of our economy. Rates will continue to rise until it seems that a soft landing in housing is replaced by something more severe, at which point we will likely see rates start to be more accommodative. Ammunition has been placed at the base of our economy. A few sticks of dynamite have already been detonated; Mortgage rules were changed, underwriting rule changes were implemented to make borrowing harder, and now interest rates are heading higher.

What makes this controlled demolition interesting is that it is happening in lockstep with a similar demolition South of the border. The US is increasing interest rates in attempt to slow their rapidly increasing asset prices. The last few days of red on the stock market is the response to that.

If you think the economy will remain resilient, consider switching to a Fixed Rate Mortgage. If you believe that we may start seeing the knock on effects of rising rates sooner you are probably in the Variable Rate Mortgage camp.

If you, or someone you know, would like to learn more about locking into a fixed rate or refinancing a mortgage, please don’t hesitate to reach out to us.

Thanks,

Marcus Tzaferis

Not ready to get a quote?

Sign up for the latest real estate market news and be in the know when you need to borrow.

You can unsubscribe at any time. Visit our privacy policy for all the details.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.