Inflating the Inflation Narrative

Tuesday saw the release of Canada’s August inflation report, and what a report it was. I am sure all the Tik Tok dancers are thoroughly wiped out this morning from all of the dances they were doing yesterday. Add yesterdays videos to the videos from Monday after the mortgage announcement, and I am sure they will be wiped for at least the rest of the week.

After yesterdays inflation report came in at a cool 2%, I heard a lot of comments like ” inflation dropped”, “inflation is down”, ” prices went down”. Stop!! Just Stop!! Inflation didn’t go down, and prices didn’t drop. Prices still went up 2% year over year. Yes, that was a slower increase than in previous months, but prices are still up. Prices are still increasing, albeit at a slower pace, but on a very high base. When inflation was ripping in 2022 at 8.9%, and then in 2023 somewhere between 5% and 6%, you are now adding ANOTHER 2% or so to those already inflated prices.

It always amazes me how we quickly went from 2.5% right down to the magical, mystical BOC target of 2% – right at the same time there is a lot of talk about non confidence votes and elections. Always amazing to me how things work out. Naturally politicians were quick to take to social media to claim that their plan is working as inflation is coming down. Of course, those same politicians blamed world forces, COVID, Russia, and everything else when inflation kept climbing, but now that inflation is slowing year over year it is all because of their plan.

Interestingly enough though, many people never look past the headline number of 2% to see anything else. No one ever really investigates further to see what is what. Lets look at some of the August numbers that went into making up the report, shall we?

Rent inflation: Rent inflation was up 8.9% year over year to hit a 40 year high

Mortgage servicing costs: The costs to service a mortgage were up 18.9% year over year

Groceries. You know, eating and such ( who need to do that anyways? ) were up 2.4% in August. Notably, grocery prices were only up 2.1% in July, so inflation on food is actually picking up.

However, we did see slower and lower inflation on gasoline, shoes, and travel tours. This is great news, because the person being squeezed by inflation was really concerned about the price of the 15 day European guided tour going down.

Last time I checked, Canadians were only allowed, or supposed to only pay 40% ish of their income to housing. That is either a rent paid to a landlord, or mortgage costs. I think we can all agree that 40% of your income is probably the largest component, right? So if the largest component is rising at damn near 9% if you rent, or 18.9% if you own, how the hell is overall inflation only 2%? I am not exactly sure I can pencil the math out there.

No matter how you slice it, inflation slowing, and interest rate cuts happening are anything but good news. Those of you calling for 50 bps of cuts at the next BOC meeting need to do a little research. Every time the BOC has cut by 50 bps the economy was a mess for 12 months afterwards. Jumbo cuts like 50 bps signal that the train is off the track, the wheels on the bus are falling off, and the plane is falling from the sky. 50 bp rate cut predictions are not something you should be looking for, betting on, or hoping we see. A 50 bp rate cut at any meeting will serve to confirm to the investment community that the economy has gone from circling the drain, to going straight down the drain. The Canada 5 year bond is telling you all is not right in the world. Bonds are pricing in a recession in Canada ( and most developed countries ).

One thing that is interesting to me is where mortgage rates stand in comparison to bond yields. Right now the banks are absolutely cleaning up on their margins. Spreads on mortgages are so thick and juicy right now. Are you getting undercut on a renewal by a Big 5 at the last minute? Probably, because banks have the margins to do so. With spreads on mortgage to bonds where they are right now, I ask you this:

Does it matter more about bond yields coming down?

The reason I ask is that everyone in our business now seems to have a part time hobby watching bond yields. Okay, great, always good to know what is going on. However, if the banks are simply going to increase their spread, it doesn’t really matter what yields do as much, since the bank is slurping up the extra. A couple of months ago I did a couple of interviews, and I said that we would only see about 1 bp of mortgage rate reduction for every 2 to 3 bps of bond yield drop. Well, here we are and banks are enjoying the fattest margins EVER. Not this year, not this decade – fucking ever!!! This will continue until at least Oct 31 when the banks all have their year end. Banks need profits right now to help offset and coverall of the loan loss provisions they are forced to set aside. They need the padded spreads to make themselves look profitable, and to help shed risk on their balance sheets.

Speaking of shedding risk, you know what else will help the banks? Lets say, hypothetically of course, that they need to write 30 year mortgage to help buyers qualify. If those mortgages are insured, even through bulk insurance, then all of that risk gets transferred off the bank balance sheet, onto CMHC’s balance sheet. This is all hypothetical of course. Imagine if banks could magically, like over a weekend out of nowhere increase the amount of their mortgages that were suddenly insurable. Just imagine how that would help banks reduce their risk, increase the profits, reduce the VAR calculations ( value at risk ) and make them seem like a lean, mean, profit machine. Wouldn’t that be something? Even though this is something that the bank regulator – OFSI said would not happen because it would not be wise, even though that was said, just imagine what that would do for banks struggling with loan loss provisions.

As we head into the fall, look to see some more trims on the BOC overnight lending rate. Also look to see how many new listings popup in your area. It seems every rate announcement simply gets more listings. It’s almost like interest rates going down are a bad thing?

Inflation was trending, and is now magically right at the BOC target. This should mean that BOC policy is not overly restrictive, or overly accommodating, but we all know central banks are always late to the party, so Uncle Tiff will take a couple more whacks at the overnight rate pinata before all is said and done. Before we celebrate victory though, keep your eye on the housing costs and grocery costs in the inflation reports. It may be telling you when the slow burning embers of inflation are ready to spark again.