Shit Got Real, Fast

Amazing what a couple of days can do to the human psyche!! If you had gone on vacation on Thursday to a remote island with no internet, and you landed back at Pearson airport tonight and turned your phone on for the first time, you would be in for a rude awakening. Over the last 2 trading days, stock markets have erased trillions of dollars in equity value, the Japanese stock market has had its largest collapse since Black Monday, and traders, investors, and financial professionals are all wondering what happened.

Now, none of this is really surprising to me. I have written blog after blog after blog explaining that the volatility was going to pick up, and the shit was gonna hit the fan. Well, here we are. The only thing that surprises me is how surprised people are that the last couple days have happened. It has to happen. This is how cycles work – and for those of you that want lower interest rates – this is how you get them. Of course, lower interest rates won’t save the world this time, but what we are seeing unfold is exactly what has to happen to get rates down. Literally financial markets and the economy have to fall off a cliff.

The largest problem with finance as a whole is the problem with bias. Never ask a barber if you need a haircut, and never ask a mortgage lender if they want lower rates. The answer will always be the same. Lenders want lower rates to juice volume – or so they think will happen. This morning Jeremy Seigel ( he is professor Emeritus at Wharton School of Business ) went on CNBC and called for the US Federal reserve to immediately cut the overnight rate by 75 bps, and then cut another 75 bps in September. Now, I took a couple classes with Mr. Siegel, and I have spoken with him a couple of times. Nice guy, and smart, but calling for the Fed to cut rates by 75bps immediately is probably the dumbest thing I have heard in a while. Now notice I didn’t say it won’t happen, I just said it was a bad idea.

Since what’s old is new again, let’s take a stroll down memory lane, shall we? The recession of 1990, 2001, 2008, and 2020 were all preceded by large rate cuts by the Fed and the BOC. Hhhhmmmm, notice a pattern? Every time a large rate cut comes out of nowhere, markets take that a signal that we are screwed, and the selling gets worse. Bad news begets more selling, which begets more bad news and round and round we go in a self fulfilling negative feedback loop.

Of course, many will claim this is a normal correction in the course of markets. I disagree. Normal functioning markets do not see intra day declines of double digits. Japan and the US are not some 3rd world nation with undeveloped stock markets. These are major trading hubs and are some of the most regulated markets in the world. You don’t simply slice 12% of the value off of world stocks because of a normal correction in 3 days. However, the great thing about an opinion is that I can have an opinion, you can have an opinion, and it doesn’t mean either of us is right. But, why in the heck should any of this matter to a mortgage broker?

A lot of things are working together right now that could bring some problems to the mortgage world. I will explain a couple of them you may not be aware of, and why they impact you.

1. Bond volatility. When bond yields get volatile like they are, lenders are not going to react as quickly as they normally do. Rates take the elevator up, and the stairs down, but now that there is volatility, rates will take the up escalator, down……. they won’t move. Lenders get scared when bonds start making large intra day moves. Hedging costs get expensive, and risk goes up. Not sure if you were aware but Canadian Banks are pretty risk averse…. It is risky to hold billions of dollars of bonds and notes that can change by the minute in a big way. So, spreads will increase. For every 2bps in lower bond yields, you will be lucky to get 1 bp in mortgage rate reduction – eventually. This will pad the spread, and make up for the perceived risk. Banks also have a tendency to clamp down on underwriting. It could be said that they close up tighter than a bulls rear during fly season. Need an exception? Better luck finding a unicorn walking down a dirt road. This is going to make it harder and harder for all but the best clients to find funding. Now, please understand, this won’t happen tomorrow, but you will notice that credit becomes tighter and tighter and tighter.
2. With world markets in a bit of turmoil, credit starts to retract. Some may call it a credit event, but I won’t. A credit event in my opinion is 2007 when we saw credit dry up overnight. This is not that, but credit will start to reduce between banks, financial markets, and eventually to borrowers. As the BOC is still performing QT, they are also still sucking liquidity out of the system, and if banks also start to restrict funds flowing out, you may find it is a dry desert for new funds. A credit event may come if we continue on the way the last few days are, but I am not ready to call that yet.
3. The wealth effect. The wealth effect will start to reverse course quickly. When people see their house going down in value, they see their investments dropping, and their retirement accounts getting smaller instead of bigger, this has a mental effect on people. People that see this start to hunker down financially, put off large purchases, and stop buying things, like, well,…..houses for one. With so much uncertainty out there, the general population will slow down with purchases of a lot of things, big ticket items being one. If we see markets continue with the volatility like we have the last few days, it will start to create negative sentiment in the market place. Someone will get nervous, need to sell, and drop their price. Others follow, and we are back to the downward spiral. Appraisals start to reflect lower values, which prices new sales in the market, and once again, round and round we go.

Now, I have been going on and on about these types of things, and have tried to give people tips to prepare for it. Many of those people told me I had no clue what I was talking about. Okay, well, checkmate. Here is what is likely to happen in the coming days and weeks:

Volatility: Things will stay wild. That doesn’t mean straight down, but you will see large swings in stocks, currencies, bonds, crypto – you name it. In fact I bet tomorrow we see a large bounce in the stock markets – this does not mean it is all over. Yields will look like they are attached to a yo yo string. Every Fed Governor that speaks will move yields. Every time someone calls for an emergency rate cut – yields will move. Every time government reports are released like CPI, employment, etc. Yields will light on fire. This is normal for this stage of the cycle. Use it to your advantage: Get your buyers pre approved and lock in rates. If they go up a lot, you look like a genius. Deal with lenders that have rate drops – there is a good chance you could be 25 to 50 bps lower at funding if things go bad. Again, you look like a hero to your client. Transfers and renewals that were sent out a few weeks ago we can finally compete with!!!!

Predictions: Oh how I love it when all the talking heads get on the media. Some will jump on and scare the shit out of you claiming the stock market is going to zero. 30 minutes later a talking head will say the stock market is going to double from here. Neither of them are correct – they are talking their own book, and most likely front running. The easiest way to make money is for me to buy bank stocks, go on national television and tell everyone to buy banks stocks. It should be illegal, but somehow they never get caught. As Mr. Twain said ” It was the best of time and it was the worst of times”. Somewhere in the middle is probably be more accurate. Do not let these people on the television determine your predictions. Some will say interest rates are going negative, others will say we are headed back to the 1980’s double digits. Neither will happen, so don’t get sucked in. Stay level headed.

Your clients – at least a lot of them, will get sucked into the news, and start to worry. They need trusted advice, and they need to make sense of it all. Be the source of trusted advice. Read as much as you can from different sources to get a handle on where you feel things are going, and prepare for that. I fully encourage people to read and listen to as much as they can so they can be as educated as possible. Bruno Valko from RMG puts out some fantastic info on his emails. I don’t always agree with Bruno, and I am sure he doesn’t always see eye to eye with me, but he has some of the best mortgage broker data in a quick, concise email format. If you want to know Canadian data that could change mortgage rates, Bruno is probably the best place to go. Ron Butler usually has some pretty good pieces out on X, and “The Tok”. Go subscribe. There are hundreds of economists that you could watch, listen to, and learn from to become better at your craft.

There are going to be some rough days ahead, and there are going to be some good days ahead. Learn to balance out the good with the bad. I am hoping that the Fed and the BOC stay out of the fold, and do not intervene with rates. The market needs to get weaned of the financial boob of low interest rates. Markets need to find their own level without intervention. When central banks intervene there is always unintended consequences. Of course, there are a lot of people out there that need lower rates to make their projections work, so they will always be calling for a rate cut in some form or another. Those same people will always call for lower for longer interest rates – the consumer be damned.

Just because we may recover from this little August sell off doesn’t mean we are all in the clear. We are heading into a dangerous time of the year – September and October, and shit could get really real – especially with a US election in November.

Keep level headed, brush up on your skills and knowledge, and put your client first, and you will be a rising star.