Look Out Below

With this mornings release of the US inflation numbers, the bond market has been on a tear. Yields have plummeted ,and bond prices are staging an impressive rally. While I am sure every realtor in the country has by now told their clients rates are dropping, and time to buy, lets look at a few things:

Yes, the 5 year yield on bonds has dropped significantly over the last couple of weeks, however it still remains elevated – at least for now. Lets remember that the Canadian inflation numbers are due out next week. I am expecting them to be worse than the US stats, so the slide in yields we see today may be an appetizer for what comes next week. US inflation only missed by .1%, and I expect Canadian inflation to miss by more than that.

While 5 year bond yields have been down, it seems that the mortgage rates are staying elusively high. As predicted back a few months ago – lenders are padding their bottom line, and increasing spread to account for economic risk. Yield drops are not copying over bp for bp. This will continue. You can jump for joy at a 100 bp 5 year bond drop, but it probably only translates into 50 bps on the mortgage rate.

Good news ( to real estate ) is actually bad news to everyone else. When bond yields go down, it means bond prices go up. The reason people buy bonds is because they want security, safety, and think that risk is coming. This may come as a surprise to people in the real estate world, but, some people have other priorities, concerns and objectives other than ensuring real estate related fields make a commission. I know, it is shocking. The only reason bond yields will trend down is because the economy is turning downwards. Inflation can quickly become deflation, and the bond market has a better nose for sniffing out future issues than almost anything I have even seen. The economy sucks right now. People are finding it difficult to put food on their tables, provide shelter for their loved ones, and keep their vehicles running. Taxes have overloaded Canadians, and make the largest share of income spent. Yes, higher rates are a part of the problem, but not the only problem.

Until we see massive reductions on pricing in housing stock, nothing will move the real estate needle. Interest rates be damned, people cannot afford to buy a house, investors cannot make money on rentals, and the flipping game is dead. Jump for joy at lowered bond yields all you want, but it won’t be enough.

While I am seeing a lot of realtors claiming rates will drop – and they are right, it still doesn’t matter. Mr. Market is no pricing in a 91% change of 100 bps of cuts in Canada by next fall. Generally when the bond market is over 85%, they are bang on. Great, the BOC cuts rates by 100 bps. That is still not enough to save everyone in a fixed payment variable that comes up for renewal. Those people are coming out of sub 2% mortgages, so even if we see Prime drop from 7.20% to 6.20% over the course of a year, there will still be carnage. 2024 and 2025 will be a real estate hell in Canada. 1 of 3 things needs to happen to correct. 1. House prices need to drop – and by a lot. 2. Interest rates need to drop – and by a lot, or 3. Incomes have to go up by around 35% to 40% ( we could also call that a lot ) . Maybe it is a combo of these 3 that happens and saves the day, however I am not betting on it.

Housing is too expensive, Canadians are loaded to the eyelids with debt obligations, and government policy is ensuring that the cost of living ( notice I didn’t say inflation, but the actual true cost of raising a family ) is super high. Sure, rates go down, but we are still not even really sure how much of the lower rates get passed on to the borrower, as lenders crank up net interest margins to account for risk.

You may be out doing a rain dance today for the lower rates, and next week may even see an encore of your rain dance, but you might want to make sure the umbrella works, because we are about to see a bunch of bad news that will make the rain into a hurricane force rain storm….