September 02, 2022 | 14:20
BoC Set to Pull the Trigger on Housing
The Canadian housing market is fully in correction mode, and we suspect two things: more weakness is on the way, and the Bank of Canada is going to tighten right through it.
Toronto housing market data for August were released this week, and they show a bit of a mixed picture. Sales were down 34.2% y/y, but were up more than 11% month-to-month after seasonal adjustment. While the turn is encouraging, activity is still bouncing around recession-like levels. The benchmark HPI was up 8.9% y/y, and still falling month-to-month as downward price discovery continues. All told, there is still a long way to go before this correction sorts itself out, keeping in mind that these results still reflect some rate holds from before the Bank of Canada’s 100-bp hammer swing (and the expected September 7 hike). You’ll know where this market is really settling by early next year.
One positive factor so far is that there is little forced selling, as new listings in August were the lowest since 2010. So, we’re at a bit of a standoff between buyers (who need lower prices to offset higher interest rates) and sellers (who aren’t being forced to liquidate). This is one major factor that can differentiate an asset price correction and a deeper collapse, the latter of which still looks unlikely.
Meantime, the Bank of Canada is expected to raise interest rates by 75 bps on September 7. This will take the typical variable mortgage rate up to around 4.8% and could begin to set off trigger payments for borrowers that took on mortgages down around the 1.5% mark. For some context, roughly $260 billion of variable-rate mortgages were advanced around the 1.5% level in the year through February 2022. That represents almost 20% of the overall mortgage market that could be subject to upside payment risk. And, someone on a 1.5% variable-rate mortgage would, after next week’s expected rate hike, be running very close to the point where monthly payments are no longer covering the interest cost. Given that each contract will vary in response, there is some uncertainty over exactly how significant this shock might be. But, suffice it to say that there is at least a modest drag on discretionary spending coming in the months ahead. At minimum, a swath of mortgages is now effectively amortizing over periods much loner than set at the outset, and these risk much higher payments at renewal down the road.
On the fixed-rate spectrum, 5-year mortgages taken out in late-2017/early-2018 (i.e., five years ago) were done so around the 3% level. Those mortgages, worth roughly $130 billion written in the year through June 2018, will now be renewing into a much higher interest rate world of 4.8%-to-5.1%, as it looks right now. There, mortgage holders could be looking at payment increases of roughly 20%, tempered by the fact that principal has been paid down meaningfully. Again, this will drag on discretionary spending.
There are two big factors working in the background to keep the fallout in check. First, OSFI has stress tested all borrowers through the pandemic at a rate of at least 4.75% (later increased to 5.25% for everyone, and then even higher for some as mortgage rates have risen). From a capacity-to-pay perspective, this should insulate the market and prevent any of that forced selling that can really fuel a downturn, at least outside the circle of highly-levered investors. Also, the job market remains historically tight which, unless the economy weakens much more than we expect, offers another layer of support.