Let Them Eat Cake

As we sit on the eve of tomorrows rate cut announcement from Uncle Tiff at the BOC, we have a lot to look at. The announcement, for what it is worth will likely be a hold, but there is just so much more going on in the financial world to look at. Uncle Tiff is in no rush to cut tomorrow, because he knows that cuts will be coming, so doing them now isn’t a really big deal. I feel it is really important to look at the WHY and HOW of a BOC announcement. It seems people are confused as to how they happen, and why rates move.

The Bank of Canada’s mandate, as set out by the government is very simple, but even though it is simple, it is often misunderstood. The only job the the BOC has ( at least in terms of setting the overnight rate ) is to keep inflation between 1% and 3%, with a 2% perfection rate. That is really it. Don’t get me wrong, the BOC does a lot of work outside of setting overnight rates, but that isn’t really within the scope of a blog. Now, we can have a very flavourful conversation about what exactly inflation is supposed to mean, what inflation number the BOC will use to determine the 1% to 3 % ( core inflation, CPI Trim, headline inflation ) but at the end of the day, the only thing the BOC is supposed to take into account is where inflation is, and where they think it is headed. That’s it, that is all. The BOC does not have an employment mandate, a housing mandate, a Canadian dollar mandate, or anything else. Now of course we all know that these other things can ultimately filter into the inflation rate, but the BOC isn’t supposed to consider the ingredients of the cake, they are only judging the final cake in front of them.

Last week we had Canadian GDP come in at a striking 2.2%, well above analyst expectations, and a very good number. I am very bearish on the Canadian economy right now, and even I was shocked. It does make a little bit of sense though, as companies and individuals were stocking up in advance of tariffs being added during Q1. It was most likely a one time surge, and we will be able to see the reversal of the GDP growth once Q2 numbers come out, but that likely won’t be until August or September. Whether or not the GDP number was due to re stocking, foreign currency, or aliens landing from outer space – it doesn’t matter, a 2.2% GDP print is certainly not something that a central banker would look at and think ” You know what, I should cut the overnight rate by 25 bps”.

So, we can tick the hold box for GDP growth, but when you look at inflation, it really doesn’t get much better either. The last reading we got on inflation had core inflation coming in smoking hot. Now, yes, I know the ‘headline’ number was ONLY 1.70%, which is well below 2%, right? Yes, but also NO. While the headline inflation number ( the number that every media outlet uses, and every Tik Tok realtor uses as their gauge ) was lower in April than in March at 1.70%, the CORE inflation number ( the BOC’s preferred inflation gauge ) actually rose to a level of 2.59%. So, the preferred method of inflation for the rate setting committee is well above the 2% number, and it is heading in the wrong direction. Strike 2 for cutting rates.

Over the last 2 months, the Canadian dollar has gained some ground on its US counterpart. It seems that we have seen the lows in the Canadian dollar in the first couple months of the year ( kinda like some random blogger said would happen ). Is it the Canadian dollar gaining, or the US dollar losing? That is up for debate, but with the CAD putting in an impressive run, it certainly will make people feel a little less depressed if they have to buy US currency. If the BOC were to cut rates on Wednesday, that would send the CAD back lower. Depreciating the value of the Canadian dollar may be good for exports, but it certainly isn’t good for the economy. The dollar has finally found some ground to rest on, and pulling the rug out from under it certainly would not help the economy right now. Importers and exporters are trying to find some semblance of normal, and moving the currency by 2 or 3 cents isn’t exactly going to help that. On top of that, if we depreciate the Canadian dollar, then it will start to send inflation higher on a lot of goods. Now I know that no one is buying American goods right now ( or so they claim ), but since the USD is the global reserve currency, a lot of things are priced in USD, and as such a lower Canadian dollar will increase the price. Whether you like the US or not, it has more to do with your well being than most policies that a Canadian politician puts forward. A rate cut tomorrow basically guarantees that the CAD loses 2 to 3 cents over the next 60 days, and puts Canada in a worse spot then it is now. So, I guess that would be strike 3 for a rate cut.

Over the last 5 to 10 years, I have really watched a big change in the BOC announcements. 10 years ago, no one in our industry even knew they happened. Hell, even if we knew, no one cared. Rates went up, or rates went down, and we all adjusted. But, the big difference from then to now is what the expectation of the BOC announcement is. The job, or mandate, or whatever you want to call it of a central banker is to react to what is going on – not to cut it off at the pass. Much like reporters should report news, rather than make news. The job of a central banker is not to cut rates to bail out people who speculated on 5 pre cons in Toronto. The BOC is not supposed to front fun a bad economy and cut rates to bail out the average Canadian. Now, it has happened, especially during COIVD, and that built up a shit load of bad behaviors. Everyone figured that the BOC had their back, and took risks accordingly. Well, guess what? Uncle Tiff don’t care about you.

The central banks have been, and hopefully always will be data driven. The issue, naturally, with being data driven is that you are always responding to the issue you are trying to fix, instead of being pro active to stop the issue. If you use data as your truth, then you can make adjustments as needed to smooth out the volatility people experience. During COVID we saw the central banker at the time stand up and give a press conference with the Minister of Finance and they massively cut interest rates. The BOC ( and many other central banks ) did a front run on the data. They knew the data would be bad, so they cut rates in advance to try and hit the bad data off at the pass. Ironically enough, the data only got bad for 60 days before most indicators turned higher. But, the worse part is that now the average person expects the BOC to do that in every crisis – whether or not the crisis is real or imagined. The number of average consumers calling for a bail out of real estate blows my mind. The job of the BOC is not to cover your gambling losses ladies and gentleman.

As Toronto real estate continues to drop into the abyss, and many house prices and sales drop around the country, the voices grow louder for someone to do something. Personally, my hope is that no one does nothing. Real estate, and the risk associated with it, needs to find a bottom on its own. People need to lose hundreds of thousands of dollars, people need to go bankrupt, and people need to feel pain in order for the market to heal. Now, I can already feel the liberals filling my inbox up with messages about me wishing pain on people. Yup. That is how shit works folks. But, for those same folks, I will tell you that there is some hope as well. Real estate is a zero sum game you see. For every $1,000.00 drop in list price on a house, it means the new buyer pays $1,000.00 less. So, the $1,000.00 is not lost, it is simply transferred to someone else. Pain felt by one person is actually pleasure felt by another – and that isn’t some 50 shades of grey I am referring to, just the real estate market. For every person who loses hundreds of thousands of market value, a first time buyer can get in the market. For every house taken by a bank under power of sale – a potential family can afford a place to raise their kids. Zero sum. When one loses – another one wins.

Maybe a steady downward trajectory in Canadian real estate is what is needed to transfer a good chunk of the homes from all the Baby Boomers down to the next generation. Of course, those same Baby Boomers were kinda, sorta promised by their incoming PM that he wouldn’t drop the value of Canadian real estate, but I guess you live and learn. Elbows Up won’t be enough to stop the real estate price drops. It won’t stop the surge in listings, and the drop in sales ( as much as 90% in some real estate boards ), and it certainly won’t keep markets from correcting. Markets correct to a median when they over value themselves. Canadian real estate was into the stratosphere, and now needs to come back down to earth. This will be a tough lesson for people who went all in on real estate.

Whether you are long housing, or simply longing to buy a house, don’t look to the BOC for help. The BOC is not there to make housing affordable or to keep prices propped up. The job is to review the incoming data and decide, if based on the data they see, and their mandate, if overnight rates need to go up or come down. Based on the data they are reviewing for tomorrows meeting – they are likely to hold the line, at least for another month.